CyberSource Corp. has released its 9th annual Online Fraud Report, which among other findings, claims that losses incurred by digital downloads providers due to fraud amount to an average of 1.8 percent of online revenues; a figure which is half a point higher than the 1.3 percent average fraud rate that was reported by all the survey's respondents.
These figures represent a fraud loss on 1.5 percent of accepted orders for digital downloads versus 1.2 percent for all online merchants.
"The fraud rates are higher for digital merchants in general, and part of that is the unique nature of the goods. When you have a physical piece of merchandise you have more time to assess the transaction before you deliver it and at the end of the day, you have someone signing for it," Lauren Wang, CyberSource market manager for media, entertainment and telecom, said. "With digital distribution, you have an email address. A lot of the tools for identifying fraud aren't applicable for digital delivery of goods and services."
According to CyberSource, U.S.-based e-commerce operators lost approximately $3.6 billion to fraud in 2007 — up 20 percent over 2006.
Although other factors can come into the equation, for most adult website operators, much of the issue of fraud centers around so-called "friendly fraud" wherein paysite customers deny legitimate charges and pursue chargebacks through their bank.
For U.S.-based adult website operators, VISA imposes a one percent cap on chargebacks — a significantly lower rate than it allows for non-adult operators — which has led to tighter controls and operating procedures throughout the industry as opposed to our mainstream counterparts.
While the report found that digital merchants tend to reject more U.S. and Canadian orders due to a suspicion of fraud, with 4.9 percent of digital download orders being rejected versus 3.9 percent for hard goods merchants, fewer foreign orders were being rejected, with 9.1 percent of download orders being declined as opposed to an 11.9 percent decline rate on hard goods sales.
Digital merchants also manually review more of their orders than do their hard goods counterparts; reviewing 40 percent of orders in comparison to an overall average of 31 percent.
"Digital merchants have a higher proportion of international customers, which may impact the way they approach order reviews," Paul Brock, CyberSource senior manager of managed services, said.
While digital merchants impose a higher manual order review rate, they are not as likely to challenge chargebacks as are hard goods merchants; with only 54 percent re-submitting chargebacks — compared to 80 percent of all e-merchants. Surprisingly, digital merchants are more successful in challenging chargebacks than are their hard goods counterparts; winning 55 percent of their claims as opposed to the 40 percent recovery rate seen by hard goods merchants.
According to CyberSource director of worldwide customer and market intelligence Doug Schwegman, the chargeback system stems from the early days of retailers accepting mail and phone orders and mandated that merchants that challenge chargebacks prove the customer did in fact receive the goods he or she ordered.
"Customers couldn't claim a fraudulent transaction if you could show a FedEx delivery sheet, signed, with the right address," Schwegman said. "Digital merchants have a more difficult time doing that, though they can sometimes show date stamps, time stamps and use geo-location devices."
According to Brock, one factor in the success rate that digital downloads providers enjoy in challenging chargebacks could be the challenges they choose to make; selecting those that have a high chance of success or that represent higher ticket items; for example, pursuing chargebacks on $200 software downloads rather than those on a 99¢ music download.
"I know of one client that experimented with re-presenting all of its chargebacks during a month," Brock said. "And it gained $40,000 as a result."
The full report can be downloaded here.
