In today’s episode, we cover’s recent study of first-party fraud or “friendly” fraud — perhaps the most in-depth ever produced on this topic — which has revealed a host of key findings. The biggest is that online merchants are unwilling to acknowledge this type of fraud, but it’s reducing their profit margins by as much as 25%.

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David Zweifler, [00:00:00] When you’re an online retailer, refunds are just one of the costs of doing business. Sometimes things get broken in transit, or the product being received just wasn’t what the consumer expected…Unless they’re a fraudster and they’re ripping you off. Today on the podcast, we’ll be talking about this kind of fraud called first-party fraud or “friendly fraud” with Whitney Anderson cofounder and CEO of which just completed what may be the most comprehensive study ever completed on first-party fraud.

[00:00:38] We’ll talk about what first-party fraud is, how much it’s costing online businesses, how to prevent it, and why so many online businesses are reluctant to call this out as fraud. We’ll also talk about why first-party fraud is so bad right now with the spike in online purchasing around the Covid-19 epidemic and how calling out first-party fraud could be a huge boost to profitability of online businesses in 2020.

When Customers Attack

[00:01:07] Thanks for joining us today. Whitney. What exactly is first-party fraud and how does it differ from other types of online fraud?

[00:01:16] Whitney Anderson, CEO and Co-founder of [00:01:16] So first-party fraud or as we call it “first-party fraud” involves individuals that are real customers, real purchasers that then claim that a transaction wasn’t completed to their satisfaction.

[00:01:31] Maybe goods weren’t delivered even though they actually were satisfied correctly. And the order was properly fulfilled. So it’s just a individual generally that is opportunistic and he’s looking to both get the good or service as well as the cash.

[00:01:54] David Zweifler, [00:01:54] I would imagine, given the profile of the potential fraudster, this would be a very difficult type of fraud to prevent and detect.

[00:02:05]Whitney Anderson, CEO and Co-founder of [00:02:05] Yes. So since they are real purchasers, and they behave a lot like real purchasers, that, yeah, they blend into, you know, the bulk of actual good purchasers in the background. So it’s a very difficult thing to detect. And, and not every transaction that they’re putting through a will end up as a charge back over is the fraudulent outcome.

[00:02:26] So as, as a result, it’s very difficult to determine which are the friendly fraudsters. They don’t try to obfuscate any of their identity or their address or their emails, or they’re acting and behaving as if they’re real purchasers and they have every intention of following through with payments.

Calls Coming From Inside The House

[00:02:45] But, yeah , it’s fairly hard to detect the first-party fraud. However, with certain tools and with certain data inputs, it is possible to do.

[00:02:55] David Zweifler, [00:02:55] Yeah. The calls are coming from inside the house. Right? I mean, you’re saying that not only are they committing fraud looking like legitimate customers, but they might make three legitimate purchases and then shaft you on the fourth.

[00:03:10] Whitney Anderson, CEO and Co-founder of [00:03:10] Correct. And one of the amazing things in (first-party fraud) is that we’ve found that once an individual kind of turns that corner. Once they get away with (first party fraud), once on average, they’ll go at least nine times, if not more.

[00:03:27] David Zweifler, [00:03:27] Wow. So, yeah. You get, once you get a taste for that (first-party fraud), Ooh, it’s a heady drug.

[00:03:35] Whitney Anderson, CEO and Co-founder of [00:03:35] It seems too easy, but you know, it’s, yeah. It ultimately comes back, you know, in the form of higher prices, you know, that the merchant then has to pass on to everybody else. So it’s not as if that it, it’s not as if it’s a victimless crime.

Merchants Turning A Blind Eye

[00:03:49] David Zweifler, [00:03:49] So the reason, that these people are, you know, doing it six or nine times is because, I believe that a lot of online businesses are not willing to label that behavior as fraud.

[00:04:03] Is that right? And if so, what are they doing.

[00:04:07] Whitney Anderson, CEO and Co-founder of [00:04:07] Well, a lot of times they have put a huge amount of effort into acquiring these customers. They have to go buy the customer. The cost of acquisition is sometimes 20, 30, 50 bucks. They go to great lengths to make sure that the purchaser has a great experience.

[00:04:24] You know, they invest heavily in acquiring these people. So, yeah, it’s kind of a kick in the pants when they turn around and actually costs them all of that effort, all the marketing expense, as well as the goods as well as the shipping costs. I mean, it can be a very pricey thing. and they’re reluctant to label somebody as a friendly fraudster because these people, you know, appear at first blush to be good customers. However, it’s only after a number of times does it, does it, does it reveal itself that the person’s actually committing fraud. 

The High Price of Friendly Fraud

[00:04:57] David Zweifler, [00:04:57] Yeah.  In the, physical retail world, if you’re a marketer and every 10th person’s an armed robber, you, you would not be very good at your job. But I guess in the online world, you get a couple of thieves in there. You know, it all works out.

[00:05:14] So this must be a pretty expensive kind of fraud, right? Because a lot of times these guys are getting the good or service and, and a refund right?

[00:05:25] Whitney Anderson, CEO and Co-founder of [00:05:25] Right, exactly. So it’s on an individual basis. It’s very expensive, as expensive or more than other types of fraud.

[00:05:33] Third-party fraud or selling, you know, straight identity theft or some other, you know, stolen payment methods, something like that usually it’s caught very early and therefore the damage can be contained much earlier and can be, result in a much smaller loss.

[00:05:49] Where as the front of the fraudsters, you know, the, the merchant tends not to label them as, as fraudsters.

[00:05:56] They keep servicing them. That will service them until the evidence is overwhelmingly, you know, points to the fact that there are fraudster. And only then do they turn it off. But by then on average nine or more, the transactions have gone out the door. So yeah, the cost to the merchants and the, digital, financial companies is quite a bit higher on the front, the fraud front.

Preventing Friendly Fraud

[00:06:19] David Zweifler, [00:06:19] So, despite all of these, apparent, all of these obvious challenges around (first-party fraud), it, it is preventable. How do you do it?

[00:06:29] Whitney Anderson, CEO and Co-founder of [00:06:29] The most significant way to prevent it is to be able to tap into a consortium data set where you know, other, let’s say, digital merchants have pooled together a lot of transactional history from these, you know, fraudsters, so that when, that, you know, the fraudster skips from store to store is they’ve been able to do in the past. They can just go, you know, on forever. The only outcome. The only downside to the fraudster is that they get cut off from a given store.

[00:07:02] So let’s say fraudster goes to The Gap orders a nine times gets cut off. You know, they’re not going to jail. They don’t get blacklisted. They just move on to the next door. You know, they, they can’t be serviced by Gap anymore, but they’ll just move on to the next door, repeat their crime, and it just goes on again and again.

[00:07:22] It’s only with a, knowledge and, insight into their extended, to their previous transactional history does one, does it become pretty obvious that, that if they’ve gotten 15 refunds and 12 chargebacks on, 35 distinct orders, then the probability that the next transaction they submit is going to be fraudulent.

Entitlement, Desperation Drive Friendly Fraud

[00:07:50] David Zweifler, [00:07:50] Right. Well, it’s a great example of, how consortium data really pays off because each one of these transactions in isolation, especially before the refund, may look legit. But when you see the pattern across multiple retailers, I guess it becomes much more pronounced.

[00:08:10] So, online fraud is going up across the board, around, the quarantine from covert 19, more online purchasing, intuitively would suggest more online fraud.

[00:08:24]But there are more customers who were erstwhile good customers turning to (first-party fraud) now. Did I get that right? And what do you think is driving that?  

[00:08:40] Whitney Anderson, CEO and Co-founder of [00:08:40] So that is correct. In general, fraud of all types actually increased during economic downturns.

[00:08:47] So there’s a strong correlation between individuals duress, their financial situation, and their propensity to commit fraud. It just so happens that (first-party fraud) is a little bit more easy to commit. So you’ll see more first-time friendly fraudsters sort of testing the system out in the dispute system that’s offered by the credit card, networks.

[00:09:11] You’ll see them testing it out more in economic downturns so we’re absolutely seeing, you know, an uptick of 40% or more in (first-party fraud) and, other types of fraud currently.

A Gateway To More Fraud

[00:09:22] David Zweifler, [00:09:22] It’s a gateway fraud… you start with friendly fraud and you’re working to the harder kinds of fraud

[00:09:30] Whitney Anderson, CEO and Co-founder of [00:09:30] Yeah, sometimes, or you know, it doesn’t get, it doesn’t get less. So once you get away with it, you’re more likely to go just on that same sort of face. You’re not likely to join an organized crime ring, but, but, if you can get away with some free shoes and a free stereo, free HDTV and some other stuff like that, you’re likely to continue that behavior.

[00:09:50] David Zweifler, [00:09:50] Any pieces of advice for online businesses looking to protect themselves against friendly fraud.

Issuing Banks Share Blame, Avoid Consequences

[00:09:58] Whitney Anderson, CEO and Co-founder of [00:09:58] So digital businesses in particular, most of the fraud they experienced is friendly fraud. So a lot of these digital download and media companies, their highest fraud category is friendly fraud. And the only way to resolve it is to, is to tap into consortium data and be able to take a peek at how this person has behaved in previous online purchases and financial interactions.

[00:10:27] And so, it’s, yeah, it’s, it’s incredibly important that merchants and the issuing banks because issuing banks, in large part help perpetuate this problem because they don’t ask their card holders, who are their bread and butter, the hard questions about, you know, about the details of a transaction.

[00:10:47] They don’t really question a lot about, chargebacks, you know, whose fault was it? You know, it’s always assumed that it’s the merchant’s fault out of the gates, and that’s why, you know, the significant majority of chargebacks are fraudulent or have some element of fraud.

[00:11:03] So it’s important both for the issuing banks and for the merchants to both try to cut this off because it’s, you know, it’s only getting worse by the week. And, ultimately it hurts the cardholders as well. So the issuing banks should take an equal interest in, cutting these bad behaviors off.

[00:11:21] So the only way to reduce the  friendly fraud  (acress the entire industry) is for the issuing banks and the merchants to ping consortium datasets. You know, FraudNet’s or I think there are one or two others.

An American Problem?

[00:11:38] But the, you know, ultimately the consortium data showing the person’s behaviors in the past is the base to be able to prevent future fraud.

[00:11:53] David Zweifler, [00:11:53] You brought up two really interesting things. First of all, what do you have a sense of what the total impact on the industry is by friendly fraud right now?

[00:12:03] Whitney Anderson, CEO and Co-founder of [00:12:03] It’s definitely in the tens of billions of dollars in the U S and its most friendly fraud, oddly enough, happens in the U S mostly a U S phenomenon, which, you know, there’s a lot of, a lot of interesting discussion that could come from that simple fact. You know, why in the U S is there more friendly fraud than in Canada or Mexico or Germany or anywhere else? You know, in an in part it’s the dispute resolution system. And in part it’s that, you know, maybe Americans are a little bit more..  .uh…

[00:12:32] David Zweifler, [00:12:32] Inherent  criminality?  (laughter)

Billions in Lost Profits

[00:12:40]Whitney Anderson, CEO and Co-founder of [00:12:40] They invite a little bit more risk. They’re maybe more, a little more entitled sometimes. And, but yeah, so I, you know, at the end of the day, it’s in the many tens of billions of dollars. And, ultimately what happens is it comes back, merchant takes a loss, but over time, the merchant. … they claim that it’s a cost of doing business, but it goes back into prices, and increased cost to all the other consumers.

[00:13:07] So it’s one of those things that’s, it’s a benefit if it can be contained rather quickly. Although, the merchants, many merchants have fallen into a routine of just considering friendly fraud as a cost of doing business, which is a huge mistake because that just perpetuates it.

[00:13:24] David Zweifler, [00:13:24] Now, that was my next question is if the merchant is racking it up as a business expense, how do you even quantify the impact at this point? How, how did you, how do you infer the, the economic impact?

A 25% Hit To Profits

[00:13:44]Whitney Anderson, CEO and Co-founder of [00:13:44] A lot of these merchants and traditional merchants operate at relatively thin margins. So it’s not uncommon that a merchant’s profit margin might be 20%. And then fraud might cut in, you know, to, let’s say 1% of their total sales that could actually reduce their profit margin, you know, substantially. So,(friendly fraud)  could reduce their profit margin by 25% for easily.

[00:14:13] In difficult times, it increases the stress of retailers into the merchants substantially. So these days, and there are a lot of online retailers, and let’s say, let’s say all the airline merchants, the airline ticketing agencies, are hugely distressed already. And to put on top of that, any sort of friendly fraud or other types of fraud, it’s, you know, sometimes it causes a true hard stop for the business. which is pretty remarkable. So (friendly fraud)  is not one of those things that can be ignored. It does grow, if it’s ignored. My only recommendation is to cut it off, to tap the consortium data — to use every tool in your tool set, and in doing so, you can actually increase your profitability quite a bit.

[00:15:07] David Zweifler, [00:15:07] The insights that you’re sharing with us today, come through your experience with fraud. But you’ve also, recently done a study on friendly fraud. Is that right?

Massive Study of First-Party Fraud

[00:15:19] Whitney Anderson, CEO and Co-founder of [00:15:19] So we did. We did a fairly substantial — probably the most substantial study of friendly fraud, where we took a hundred thousand chargebacks as a sample set and did an incredibly deep analysis and categorization of those chargebacks. And we really dug deep.

[00:15:53] Actually the most disturbing of all the facts, which I don’t think  is sufficiently appreciated is the fact that for every chargeback and every known fraudulent event, on average, they’re two refunds that are not accounted for as fraud. They’re accounted for as a customer refund.

[00:16:19] But the intent behind the refund, it’s still fraud. Somebody called up, claimed they didn’t receive the goods of the service and that they’re going to initiate a charge back. And so since the merchant has no choice, they refund the money before the charge backs actually initiated.

Chargebacks Just Tip Of The Iceberg

[00:16:39] Those chargebacks get all of the analysis and you know, attention from both management at these merchants as well as the bankers. However, the majority of digital friendly fraud, actually, doesn’t even  happen at the chargeback level. It’s happening underneath the business every day, hundreds or thousands of times a day, and it goes to completely undetected and it’s just accounted for in a different way, which is, maybe more acceptable for, for management.

[00:17:10] What we see at the chargeback levels only really sort of a minority of the total problem.

[00:17:20] David Zweifler, [00:17:20] It’s kind of an insidious problem, but I guess if you look at it the other way it’s a potential source of profitability, in what might otherwise be a down-market

[00:17:33] Whitney Anderson, CEO and Co-founder of [00:17:33] I guess that’s one way to look at it. The silver lining is that a lot more profits that can be generated than sometimes management at these merchants is aware of. That’s the good news. The bad news is that right now, it’s going out the door.

[00:17:46] David Zweifler, [00:17:46] Thanks for joining us today for the podcast. I’m David Zweifler and I’ve been speaking to Whitney Anderson, CEO and co-founder of about (first-party fraud).

[00:18:00] just completed what may be the most comprehensive study of (first-party fraud) ever produced, and it’s available for free. Click the link in the description to take a look.

[00:18:11] leverages machine learning and collective intelligence to make digital transactions safe.

DOWNLOAD the full report here.