Merchants that sell digital goods each spend an average of $10.1 million a year on fraud-related costs — and many expect fraud and chargeback costs to rise in the coming months in the wake of the EMV chip card migration at the point of sale.
Card-not-present transactions are particularly problematic for digital goods merchants selling virtual gift cards, video games, movies or music because they can't delay a transaction to analyze it for risk.
"There is no manual [fraud] review in the digital goods business," said Al Pascual, senior analyst for Javelin Strategy & Research. "You can't stop in the middle of an MP3 purchase or a digital ticket purchase, or make people wait a couple of days for the movie they want to download at that moment."
Nearly three of every four merchants dealing in both digital and physical goods view fraud and chargebacks as having a major financial impact, accounting for between 13% and 20% of their operations budget, with digital goods merchants reporting figures at the higher end, according to new research from Javelin for fraud-prevention provider Vesta Corp.
Digital goods merchants are making split-second decisions about transactions, leaving them vulnerable to fraud and chargebacks if they do not have significant in-house help or support from a third-party vendor, Pascual said.
But in-house help is costly as well. Digital goods merchants employ nearly five times the fraud personnel as physical goods merchants and nearly twice as many as hybrid merchants, or those that sell both physical and digital goods, the report said.
"They invest all of this money in the back office for personnel to handle chargebacks, just because of the nature of their business," Pascual added.
To develop the report, Javelin conducted an online survey during the month of June of 362 merchants earning $1 million or more annually. Of the 20% of an operating budget a merchant may devote to fraud and chargeback costs, they said they spend between 36% and 41% of that figure on personnel.
"As card-not-present fraud grows, merchants need to consider whether or not they want to stay in the fraud business and whether 20% of their budget to do so is sustainable," Pascual said. "Otherwise, they have to find some other way to manage fraud and chargebacks."
If digital goods merchants are not sure about outsourcing those tasks, they may want to confer with hybrid merchants, 65% of whom said outsourcing fraud mitigation and chargeback management is cost-effective.
In addition, e-commerce merchants in general can't bank on the major card brands to continue to absorb chargeback costs on low-value transactions, a trend likely to continue during the first phases of the U.S. EMV migration because chargeback process costs would be higher now that the liability shift has taken effect.
"The card brands consider the number of total chargebacks, as well as the ratio of chargebacks to sales, when considering whether merchants should be included in any chargeback monitoring programs," said Christopher Uriarte, chief strategy and payments officer for Atlanta-based Vesta Corp.
A small spike in chargeback rates can throw off a merchant's fraud ratios, Uriarte said. "Once they enter the chargeback monitoring programs, the card brands will insist the merchants put a more effective fraud control program in place, or increase chargeback fees and potentially assess fines."
Vesta seeks to help merchants avoid all of that through real-time transaction screening and also guaranteeing that it will absorb the cost if a transaction it approves ultimately results in a fraudulent chargeback.
Vesta and other organizations like it are trying to get the message out that some difficult years of chargebacks lie ahead in the EMV world. Getting that message out won't be easy, Uriarte said.
"We know that there are many merchants who are very tuned-in to the changes that are coming along with the EMV liability shift, but we suspect that most merchants don’t really have a true appreciation for what it means," Uriarte said.
Many industry surveys predicted that only 40% to 50% of all merchants would be EMV compliant in time for this year's liability shift, which took effect Oct. 1.
"So you have to assume that a large number of merchants aren’t aware of the potentially large migration of fraud that will most likely shift from the card-present environment to the card-not-present environment," Uriarte added.
Costs aside, the difficulty in finding and training staff to properly handle fraud mitigation is a concern for merchants. More than 60% said that finding qualified personnel for fraud and chargeback management is a difficult process, the report said.
They also consider training cost-prohibitive because the changing fraud trends could result in nearly continual employee training and rollover.