When Is Outsourced Fraud Prevention Cost Effective?

Fraud as a percentage cost of revenues has steadily climbed over the past several years, from an average of 0.51% in 2013 to 1.80% in 2018, and that number is expected to keep rising as CNP fraud continues to grow. As the costs of fraud rise, so does the importance of building a cost-effective fraud-prevention plan. Does it make more sense to handle all your fraud-screening practices in house or to outsource some or all of it? Here are some key factors to consider when making that decision.

Costs of Completed Fraud

The average number of completed fraud transactions per month has more than tripled since 2013, and the average cost of completed fraud climbed from $120 to $184 during that time, according to LexisNexis. But each merchant has its own fraud data to use in evaluating fraud-prevention options.

First, know your chargeback costs. Approximately 30% of chargebacks are filed due to transactions made with a stolen credit card. A single chargeback can cost a merchant anywhere from $20 to more than $50 in merchant bank fees alone, not including the loss of revenue.

In addition to knowing the dollar cost of chargebacks, it’s important to monitor your business’ chargeback ratio. If more than one percent of the total monthly transactions are charged back, then the chargeback ratio is above average. That usually prompts merchant banks to charge higher transaction processing rates. In cases where the chargeback ratio rises to an unacceptable level very quickly, the bank may suddenly close the account.

The cost of employee time spent responding to chargeback requests and the cost of revenue lost to fraudulent orders are other factors to consider. When totaling up the costs of completed fraud, it may be helpful to compare your numbers to information from LexisNexis’ 2018 True Cost of Fraud Survey. That report found that every dollar of fraud costs merchants an average of $2.94.

Costs of Preventing Fraud

Preventing fraud is essential to controlling costs, but it comes with costs of its own—especially when merchants adopt rules that automatically reject flagged orders. Automatic rejection typically leads to a high rate of false declines—good orders rejected in error—and these false declines cost merchants more than completed fraud does. US merchants alone lost an estimated $331 billion in 2018 to false declines.

These mistaken rejections impose longer term costs on merchants, as well. As many as 80% of customers say they take their business elsewhere after a bad experience. False declines reduce the lifetime value of existing customers who don’t come back, and they force merchants to spend more acquiring new customers to replace the ones who left. In the highly competitive ecommerce space, the cost of customer acquisition can range from as little as $10 to more than $100 per customer.

To avoid driving up false decline costs while fighting fraud, merchants need to manually review flagged orders. In some cases, reviewers need to contact customers to authenticate transactions. It’s important to factor in training and operation costs—current or estimated–for an in-house manual review team. Ongoing training is also important to keep the team current on new fraud tactics and trends, such as account takeovers, synthetic identity fraud, shipping fraud, and botnet-powered fraud. These training costs must be factored in, too.

Finally, it’s a good idea to think about how the business could recover from a sudden spate of fraud, such as a botnet-powered surge in fraudulent orders or a high-ticket-value fraud that gets past fraud controls. How would a sudden loss of a large amount of revenue or a spike in chargeback costs affect the business’ cash flow? Is there cash on hand to cover unexpected fraud-related costs?

Fraud Prevention Program Options

The numbers will tell you whether it makes more sense to maintain a fraud prevention program entirely in-house or to outsource some or all of it. An effective anti-fraud program includes multiple layers of screening, scoring, and other preventive tactics, so it’s possible for merchants to mix and match in-house and outsourced services according to their specific risks and budgets. For example, some merchants find that it makes sense to outsource manual review of flagged orders during the busy holiday season, but not during slower times of the year. Some merchants opt for services that cover the cost of fraud-related chargebacks so they can take that line out of their budget.

Because fraud tactics, consumer habits, and market conditions are always evolving, it’s a good idea to review your fraud prevention costs regularly to see if your approach is still generating good results and controlling costs. Building and maintaining a cost-effective fraud-prevention program is possible when you know your numbers.

Rafael Lourenco is Executive Vice President at ClearSale

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