What is “Friendly Fraud” or First-Party Fraud?

There are a million different challenges to tackle in business, all to get people to trust you enough, to like your product enough, to give you money. Surely that’s the end of it, right? Unfortunately, not quite.

As anyone who has sold anything for long enough can attest, there will always be some attrition. Sometimes it’s legitimate, cases of fraud with stolen card information. Other times it’s the so-called “friendly fraud.” Friendly fraud, also known as first-party fraud, isn’t necessarily fraud at all… at least not right away. Unfortunately, it’s very real, and it costs merchants around the world over $50 billion annually.

What is friendly fraud, what causes it, and what can you do about it?

What is Friendly Fraud and How Does it Work?

Traditional fraud is third-party fraud. It’s fraud that takes place when a third party, unaffiliated with the customer (the first party) or the merchant (the second party) uses financial information to make a purchase.

First-party “friendly” fraud is reports of fraud where the customer believes fraud has occurred and submits a report to process a chargeback with their bank or credit card.

Imagine, if you will, that you’re reviewing your bank statements or credit card statements for the month. You’re going through it line by line. Here’s your mortgage payment. There’s your grocery bills. Your impulse burger at the restaurant. That game you bought on Steam for your kid. It all adds up.

But then you see an entry you don’t recognize. Maybe it’s small, $10 or $15. Or maybe it’s a little larger, $50 or $60. Whatever it is, you don’t recognize it.

Is this fraud?

The more you think about it, the more you think it is. You can’t think of anything you purchased or ordered for that amount in that timeframe. The name on the transaction doesn’t ring any bells.

So, you call your bank or credit card company, and you follow the process to report fraud. They’ll ask you a few questions, confirm details with you using the information they have, and skim through other recent transactions to see if any other charges also look like fraud. Then they’ll do their investigation. Sometimes – rarely – they’ll find that the transaction is verifiably legitimate. Most of the time, after the investigation, they’ll issue the chargeback.

Meanwhile, you’re going through the tedious process of closing your existing card, and replacing the saved number in all of your various subscriptions and ongoing charges, hoping everything goes smoothly.

Maybe that’s when that gift you ordered for mom from a small vendor arrives, and you realize; that wasn’t a fraudulent charge at all, just one you had forgotten about.

Oops.

As a merchant, this plainly sucks. The money from a sale that you thought (or hoped) was safely in your account has now been charged back, forcefully removed from your account, and in some situations, potentially even risking overdraft. As a vendor, you don’t have much in the way of protection here. Your product has been sent out, too, so you’re out twice as much.

There’s a reasonable expectation that some fraud is going to occur, but friendly fraud hurts more, because all of the hallmarks of third-party fraud are missing and it’s more difficult to catch.

What Causes Friendly Fraud?

The scenario outlined above represents one of the possible reasons why friendly fraud occurs, but there are other reasons as well.

1. Transaction Confusion

Broadly known as transaction confusion, there are a bunch of different reasons why a person who made a purchase might not recognize it.

Just to give you a few:

• The merchant name on their statement is unclear. Major retailers are generally well-named on the back end of the payment processors, but smaller businesses often have odd names, abbreviations, or names reflective of previous LLC names that don’t match what the business is doing business as these days. It’s easy to think a charge is fraudulent if the name attached to it isn’t a business you recognize!
• The customer forgot that they made the purchase. Many people are creatures of habit, and their general purchase history is fairly similar from month to month. So, if they purchase something outside of the norm, at small online merchants or local vendors or in another form they don’t normally, the unusual charge sends up red flags and they don’t remember making the purchase, at least not right away.
• The customer has a secondary user for their card, who made a purchase but didn’t communicate about it. A husband making a purchase and a wife not knowing what it is can raise concerns of fraud, and if the paid don’t communicate well enough, it can lead to a chargeback.

This is one of the most common causes of friendly fraud, but not the only one.

2. Second-Person Transactions

Similar to the third example above, second-person transactions are when someone in the household gets ahold of the card or banking information and makes a purchase, only for the primary cardholder to discover it and view it as fraud.

One of the most common examples of this these days is microtransactions and digital purchases in online games and services, especially those aimed at children. A child knows that, to get more money for Roblox or Fortnite, they need a card. They know their mom has a card in her purse. How bad could it be to borrow it? Maybe she won’t even know!

When mom checks later, she finds one (or several) charges for this game. Maybe she doesn’t recognize it, or maybe she doesn’t even know her kids are playing that game. Either way, it comes out of nowhere, and seems a whole lot like fraud. Chargebacks ensue.

There’s an entire debate to be had about the ethics and morality of commercialized microtransactions in media aimed at children, but that’s not something I’m here to cover today.

3. Misuse of Fraud Protection

Confusion and miscommunications leading to chargebacks for legitimately-ordered products is fraud, but it’s called friendly fraud because it’s not maliciously done. However, first-party fraud can also be done maliciously.

• The customer orders a product and, once it arrives, submits a chargeback simply to get the product for free.
• The customer orders a product but it doesn’t fit what they wanted, or it doesn’t meet their needs; rather than go through the returns process, they simply report it as fraud.
• The customer requests a refund but they’re outside of the refund policy window, or are otherwise not eligible, so the refund is refused; they opt to escalate to a chargeback rather than eat the cost.

These kinds of misuse of fraud prevention and chargeback processes are much more intentional and less friendly than unintentional fraud. It is, though, still fraud.

Even in cases where the customer’s complaints are legitimate – a product didn’t arrive as advertised, or didn’t arrive at all, or was damaged in transit – resorting to a chargeback is considered fraudulent. Companies should have mechanisms for handling these kinds of claims, and issuing refunds. A chargeback hurts the company more than a refund even if the financial number is the same.

4. Legitimate Grievances

In rare occasions, there may be a legitimate reason why a customer opts to get a chargeback. For example, if a glitch in your system double-charges or double-processes an order, and they’re charged twice for an order of one, they may wish to submit a chargeback to recover their money.

Again, this is a situation where contacting the company and having the problem resolved should be the appropriate response. But, sometimes, this doesn’t work out. Maybe the company’s records don’t indicate the glitch happened. Maybe communication is simply poor. Maybe the hoops required to prove it are too steep for the comparative amount of effort. Whatever the reason, the customer chooses, again, to chargeback rather than wait for a refund.

This is fueled by a certain amount of gap in financial literacy. In fact, as much as 75% of customers (or at least, respondents of a particular survey) believed that a chargeback and a refund were equivalent, and were both valid methods of resolving a dispute.

From a customer’s point of view, it certainly makes sense. Calling a chargeback to get $50 back, or having a refund to get $50 back, are both pulling $50 from the business back to the customer’s account. The difference lies only in who initiates the monetary transfer.

From a business point of view, it’s much different. Merchants have to pay fees on chargebacks where they don’t on refunds. Those fees vary from industry to industry, with high-risk industries having much steeper fees.

On top of that, merchants suffer penalties when their chargeback ratio gets too high. If you have too many chargebacks, you can even lose access to your accounts or payment processors.

How to Handle Friendly Fraud

Friendly fraud is a difficult problem to address, primarily because of the complexities surrounding all of the possible causes.

Some of those causes are relatively easy to deal with. Having a clear merchant name that matches the brand name you use to do business, for example, is a relatively simple way to cut back on one particular cause of friendly fraud. It does require you to jump through hoops with every payment processor you use, but at least it’s a one-time task.

Other causes simply can’t be avoided. There’s nothing you can really do if someone’s kid buys something from your store without their parent’s permission. That’s a parenting problem, though you could put some kind of verification controls in place to try to cut down on unauthorized users.

One thing you can do is keep in contact with your customers, especially if you have longer fulfillment times. People are used to the instant turnaround of ordering from Amazon with next-day delivery, so smaller merchants with weeks of turnaround time lend themselves to forgotten transactions. Enrolling customers in updates to their order’s fulfillment can be seen as annoying, but they at least keep the purchase in mind.

I also highly recommend making your refund and returns process as simple and clear as possible. The more hurdles a customer has to jump to prove that a product didn’t arrive, arrived damaged, or otherwise didn’t meet their expectations – and the more walls you put in place to minimize refund requests – the more likely they are to turn to a chargeback instead.

Let’s face it; there will always be some attrition in customers. You probably aren’t going to salvage a purchase that is going to chargeback, at least not very often. But, appropriate, proactive communications can convert those chargebacks into refunds instead, and save you the fees and damage to your business reputation that chargebacks leave hanging around your neck.

Technical Solutions to Friendly Fraud

Another option is to look into more technical solutions to first-party fraud. Chargeback prevention is increasingly common as an option, using modern data access, rapid communications, realtime alerts, and more.

A chargeback prevention system like Fight Disputes sits between your customers and the payment processors you use. When a customer initiates a chargeback, instead of processing that chargeback immediately, we notify you. You can then reach out to the customer.

• If the dispute was accidental or due to forgetting a purchase, they can reach back out to their bank and cancel the dispute. Problem solved.
• If the dispute is fraudulent, you can proactively issue a refund. Same result for the customer, but far less penalty for you, the merchant.

You save money, you keep your chargeback ratio low, and you cut down on accidental friendly fraud, all with one service.

The best part is that it costs less to use Fight Disputes than it does to let the chargebacks through. Stop fraud in its tracks and save money while you do it. What could be better?

All you need to do to fight payment disputes is start your application here. With our direct connections to all the big payment processors, we have the best response times and top-tier access to dispute data to ensure you’re taking the right steps, the right way, every time.

While you’re at it, ask about our managed replies!