How to Prevent Friendly Fraud in Your Small Business

By Alexandra Sheehan

Don’t be fooled: Though friendly fraud might sound nice, it’s anything but. Friendly fraud is still fraud, and it’s detrimental to businesses across the globe. 

Fraud is THE top payment-related challenge retailers face. And it’s even worse for SMBs: Businesses with fewer than 100 employees lose twice as much per incident than those with 100+ on staff. 

Below, we’ll take a look at what friendly fraud is and how you can prevent it from eating into your revenue. 

What is friendly fraud?

The friendly fraud definition is when a customer contacts their bank for a refund for a charge from a merchant for a legitimate transaction. Essentially, a transaction is authorized and processed, and the customer contacts their credit card company directly to dispute the charge and request a refund at a later date. 

Sometimes, friendly fraud is an innocent mistake. Maybe the customer made an error in the delivery address, someone else in their household used their card to make a purchase, or they didn’t understand the recurring billing terms. Many consumers don’t understand the difference between a merchant refund and a credit card refund. 

Other times, friendly fraud is intentional. These consumers are looking to get something for nothing. Some refer to intentional friendly fraud as chargeback fraud

“People consider fraudulent chargebacks of this type to be different from friendly fraud but others feel that this distinction is largely academic since the effect on the business is the same,” says Emily Stork, corporate attorney at Holland & Hart LLP. (Note: Emily is not offering legal advice and that individuals should consult a lawyer if they have questions about a specific legal situation.)

“It’s just referred to as friendly because the consumer may honestly think that they’re entitled to this refund,” says Justin Lavelle, chief communications officer at BeenVerified. “This is in contrast to chargeback fraud where a cyber criminal is intending to use the chargeback process to obtain a refund for products or services.”

Though no merchant wants to be the victim of any kind of fraud, chargebacks are often more difficult to deal with. “Customers who tried to commit chargeback fraud are usually hard to get ahold of, and if you do get ahold of them they’ll insist they were the victim of fraud,” says Stork. “Friendly fraudsters are typically easier to get in contact with and will reveal that they were confused.”

Consequences of friendly fraud

When facing friendly fraud chargebacks, merchants suffer in a number of ways: 

  • Money loss: Friendly fraud takes a financial hit at SMBs, beyond simply the loss of cost of goods sold (COGS). “The credit card company will apply chargeback fees, and the business has to pay transaction fees as well as shipping costs for nothing,” says Stork. “For a small business, these additional indirect costs may be a much larger burden than to a bigger company with more access to liquidity.”
  • Damaged reputation: If you have too many instances of fraud, this will create a poor image in the view of banks and payment processors — you could be put in ‘friendly fraud jail.’ “Any business is monitored for their fraud rates, dispute rates, and chargeback rates by their payments providers,” says Yana Afanasieva, former PayPal and Amazon compliance leader and current founder of The Consultancy Company. “If these rates get riskier, the payment provider can require risk reserves, charge higher processing fees, and even refuse to continue the relationship.”
  • Time investment: Employees may also spend working hours managing friendly fraud cases. “The onus falls on the small business merchant to prove that the chargeback wasn’t legitimate, rather than on the consumer who filed it,” says Lavelle. “The reality is, most chargebacks that are fought are not reversed, so it’s time and money lost.

How to prevent friendly fraud

“Businesses can challenge most chargebacks, but it’s time-intensive, and the chance of getting it reversed aren’t that high,” says Stork. Prevention is key, particularly for SMB merchants.

“Small businesses are particularly vulnerable to friendly fraud because they often don’t have the time, access to data, or personnel resources to efficiently investigate disputes, which can result in legitimate transactions being refunded,” says Rick Lynch, senior vice president, business development at Verifi. Here are some ways to mitigate your risk so you don’t have to endure the time-consuming process of disputing a chargeback:

Validate every transaction

When a customer pays with a credit card, it’s a good idea to ask for photo identification verification and for them to provide additional details — things like billing zip code or email address. 

“Insist on strong authentication combined with instant notification to the owner, so that they’re immediately notified when a transaction happens,” says Afanasieva. This can tip customers off instantly that their card’s being used, so they can get in touch with you in a timely manner if they suspect the charge is unauthorized. 

You can also be a victim of friendly fraud online if you have an ecommerce channel. Ecommerce friendly fraud can be prevented with strong authorization and authentication software, like CAPTCHA. For order fulfillment, use delivery confirmation emails, require signatures for delivery, get tracking information, and make sure your shipping company will provide delivery confirmation. 

Collect customer data

Getting information about the customer isn’t just to verify they’re the cardholder and authorized them make the purchase. This also helps you collect the data you need to follow up with them should there be any disputes with the order. 

A well-organized customer database can centralize this information in a searchable database. You can learn about their purchase history and identify ones that seem out of the ordinary, and you can also identify who the fraudsters are. 

Find the fraudsters

On that note, it’s important to keep track of who is filing friendly fraud chargebacks against your company. When it becomes a trend, then it’s a problem — and you likely have a friendly fraudster on your hands. 

“For example, is the same customer routinely claiming that their package was stolen, yet other customers in the same area aren’t having that problem? It’s impossible to prove it wasn’t but a business can implement new shipping rules that will ensure a package isn’t left,” says Lavelle. 

In some cases, you can even get a list of known fraudsters in your area. “If it’s legal where your business is, get a list of people who are serial chargeback-ers from a data service,” says Stork. 

Make the return process clear and easy

Retailers lose $18.4 billion annually to return fraud. It’s one of the biggest contributors to this problem. 

That’s why it’s so critical to clearly communicate what your return policy is, and to make it easy for customers to make legitimate returns. If they don’t know how to return an item or think it’s going to be a difficult process, the convenience of filling out a simple form to their credit card company becomes that much more appealing. 

“A clear return policy should be displayed at the point of purchase, including [additional] costs and how refunds are processed,” says Lavelle. It’s important to set expectations so customers aren’t left guessing.

“Effect legitimate refunds and cancellations as soon as they’re requested,” says Stork. “If you’re slow to provide refunds, you increase your risk of the consumer deciding to just get a chargeback instead.”

Scrutinize high-risk transactions

Some transactions are more likely to be cases of friendly fraud than others. Stork recommends taking a careful look in these instances, possibly requiring administrative approval to process the transaction. Such instances include: 

  • International orders
  • Unusually large orders
  • Zip code / location trends
  • Orders that are significantly different from customer purchase history

Communicate with your customers

Consumers aren’t always aware of the negative effects a chargeback can have, especially for a SMB. It’s a good idea to educate them on the difference between a chargeback and a refund or return, along with how to get their money back (like we stated above). 

For recurring or subscription-based billing, you’ll also want to give customers a heads up about the impending charge. This gives them a chance to ask questions or cancel before the payment is processed.

Document everything

Documentation is key, both for prevention and if you do have to dispute a case. Clearly documenting your pricing and policies can help set expectations for customers so there are no surprises. 

And should you have the unfortunate job of disputing a chargeback, this documentation is going to come in handy.

“Keep all documentation for each transaction to ensure that there’s ample information to deal with friendly fraud,” says Lavelle. Remember to be thorough — too much is better than not enough in this case. 

Be easy to contact

Like we mentioned earlier, many times customers conduct friendly fraud simply because they think it’s the easiest way to get their money back. “Make it easy for customers to contact you 24/7 and be responsive when they do,” says Stork. If you make it simple to get in touch with you, then you can be their main point of contact instead of their credit card company — and you can handle the issue or refund in a way that makes the most sense for your business. 

Choose your payment processor carefully

It’s important to use a payment processor that takes its own steps to prevent merchants from becoming friendly fraud victims. “Read contracts with the payments providers carefully and understand what happens in cases of fraud claims and disputes,” says Afanasieva. “Some payments providers offer seller protection for SMBs, so there’s a way to pay to your payments partner to handle this risk.”

Here are some resources to help you find the right payment processor: 

Invest in fraud management

“It could be pricy, but there are fraud management tools that detect unusual behavior,” Afanasieva. Check out tools like Kount, Simility, and Verifi to turn fraud prevention on autopilot. 

Lynch points out that this investment is worth it, though. “Many small businesses still believe that they can’t afford to deploy fraud prevention tools and mechanisms, but the truth is they can’t afford not to,” he says. “Outsourcing these processes to an efficient end-to-end solution is the best use of resources for SMBs, since it takes the burden off staff so they can focus on actually running their business and keeping customers happy.”

Combating friendly fraud claims

“Merchant businesses should fight every chargeback when they believe they’re in the right,” says Lynch. Prevention is a lot easier than disputing friendly fraud, but no matter how hard you try to keep it from happening, you might find yourself in the unfortunate situation where you do need to make your case. 

“Fighting friendly fraud is often difficult, to say nothing of time-consuming,” says Lavelle. “The consumer-focused credit card companies aren’t likely to change their current stance on how they handle them, and with chargebacks being fairly rampant, they don’t have the time to do a deep dive on whether each is legitimate.”

That’s why it’s important to do your due diligence to make the best case possible. “It’s important that a business store and retain all transaction-related data and be prepared to submit this data should a chargeback occur,” says Lynch.

Documentation should include transaction details — date, amount, cardholder, what was purchased, location, etc. — as well as things like your return policy, email correspondence with the customer, shipping details, and anything else that can support your side. 

“Potentially, SMBs can request that the victim file a police report for the case, which will theoretically require the police to investigate the case and find the fraudster,” says Afanasieva. Note that this isn’t always feasible.

Your payment processor might also be able to handle the case for you, depending on your contractual agreement. Some fraud prevention tools will also take care of this process on your behalf, so you don’t have to manage every little step of the process. 

Moving forward with fraud prevention

Friendly fraud is just one type of fraud that merchants need to be privy to. There are other fraudulent scams that prey on SMBs. But if you’re informed and prepared, you can mitigate risk and protect your hard-earned money. 

Check out these articles to give you more ideas to safeguard your biz: