What Is Friendly Fraud, and How Can It Be Prevented?

Banks and other financial institutions have a vested interest in protecting their customers from fraud. What if someone steals a cardholder’s information and uses it to make fraudulent purchases? What if a consumer orders a good or service from a business but never receives it? In cases like these, consumers can file a claim known as a chargeback to dispute the charge. If approved, the issuing banks or credit card companies will reverse the transaction, essentially charging the merchant back for the money owed. 

While chargebacks are a useful tool for the honest consumer, bad actors are constantly looking for ways to take advantage of the systems meant to keep them at bay. What works well for buyers can represent a massive vulnerability for the merchants who serve them. Friendly fraud is one of many ways that fraudsters exploit consumer protections to scam merchants out of revenue and assets.

What is friendly fraud?

Friendly fraud, also called chargeback fraud, occurs when a person uses a chargeback to mark a legitimate purchase as fraudulent. When someone successfully gets away with a fraudulent chargeback, they can have their cake and eat it, too–the fraudster keeps the merchant’s products without having to pay for them.  

Though it’s as illegal as any other type of fraud, friendly fraud chargebacks represent a common threat to businesses because virtually anyone can file one. 

In fact, some people commit this type of fraud by accident. Consumers may not realize that a transaction can be legitimate even if they don’t like the product once they receive it. In another scenario, a customer may assume a package in transit isn’t coming and file a chargeback prematurely, leaving the seller’s hands tied. 

In yet another example, two approved users on the same credit card might have arguments about what the other orders. Just like with the other cases, the purchase may be legitimate in the eyes of the law, but the cardholder requests a chargeback anyway. 

All of these scenarios represent situations that are completely out of the seller’s control. Though sellers can sometimes successfully fend off a chargeback by providing documentation that the transaction was legitimate, they aren’t always lucky enough to win the fight against friendly fraud. Just like with other types of fraud, prevention and detection are key in the world of chargeback abuse.

The damage of friendly fraud chargebacks

There are a few different ways that chargeback fraud can damage a business. First, a chargeback scam can damage a company financially. If a customer receives all of the benefits of a good or service but doesn’t pay for it, then they effectively committed theft against the company. 

The consequences don’t stop there. A business that sees a high level of chargebacks might even face penalties from its payment processor. In the worst-case scenario, a payment processor might cut ties with a merchant or force them to pay higher rates. 

Lastly, rampant friendly fraud can cause a ripple effect that touches other areas of the business, such as logistics. If the company is constantly fighting back against phony chargebacks, it may be forced to restructure its pipeline or even downsize to compensate.

What about friendly fraud insurance?

Some companies use chargeback insurance to help protect themselves against friendly fraud. This approach can help maintain the bottom line, but it’s not without its own drawbacks. 

Insurance companies may want evidence fraud was committed to verify that the insured client is not committing fraud against buyers. This evidence-collection process takes time and resources that many businesses can’t spare. 

Because insurance companies also worry about their claims systems being abused, they’re unlikely to make exceptions or streamline their timeline for any one customer. 

That said, this type of insurance may be helpful to companies that see a significant amount of fraud or who offer especially expensive goods and services. 

Like with any investment a business makes, the cost has to be worth the results. In some cases, fraud insurance can save a company money they would otherwise lose to scammers. Still, the best solution for fraud will always be to detect it before it ever happens.

Protecting against chargeback scams

Chargeback insurance may or may not represent a good solution for a given business. But even if a merchant does decide to invest in costly monthly premiums, insurance should by no means be the only line of defense against chargeback fraud. 

Keeping instances of fraud low is in a business’s best interest whether they’re insured against it or not. Regardless of insurance status, frequent chargebacks can cause complications and introduce problems with a merchant’s payment processing provider. So, what can companies do to stop friendly fraud before it gets a foot in the door? 

Many solutions to friendly fraud overlap with other fraud detection solutions. Because some friendly fraud can sometimes follow the same patterns as other types of fraud, keeping an eye on risk factors such as account age, new locations on old accounts, unusual purchase habits, and others can help businesses reassess suspicious orders. 

Detecting fraudulent chargebacks faster

The faster a company can detect fraudulent chargebacks, the faster it can act. In some cases, a merchant may even be able to stop the order from shipping out to a customer with intention to file a chargeback on it.

Unfortunately, companies concerned about friendly fraud can’t rely on payment processors to step in and notice the problem first. Even if a friendly fraudster’s bank or credit card company does notice a pattern of suspicious chargebacks on the account, they can easily scam businesses out of multiple orders in the meantime. 

As touched on in the section above, a company should design its apps and website with tools that can quickly detect unusual activity. Suspicious accounts can undergo flagging for a more thorough review. 

Additionally, companies should keep an eye out for cases of accidental friendly fraud. Sometimes, a customer may make a purchase late at night or in the middle of a busy day and forget about it later. That’s why it’s up to business owners to step in during the chargeback process and help customers recognize their own purchases. Additionally, businesses that ship physical goods should communicate clearly about any tracking numbers or expected delays to prevent chargebacks from an impatient buyer. 

Legal repercussions

If chargeback abuse is severe, merchants might also consider taking legal action against perpetrators. However, mileage varies with this solution, and it won’t work for everyone. 

For single, isolated incidents where individual chargebacks on minor purchases, legal action is rarely effective. The time and money investment required to make fraudulent claims and win the case is likely far outweighed by the revenue actually lost on the fraudulent transaction. 

That said, when it comes to systematic or major fraud incidents, the scenario changes. In these cases, a company may need to recoup significant losses, and legal action may help them do so. 

As always, consult a lawyer before taking any legal action. Enlisting the help of a professional can help ensure merchants spend their resources effectively and understand the most likely results of their actions.

When left unchecked, this type of fraud can do serious harm to a business over time. Merchants can protect themselves from this type of scheme by using a dedicated anti-fraud system and encouraging clear communication with all of their customers.