The false promise of chargeback guarantee models in fraud detection

What are chargebacks, what should online merchants look out for with a chargeback guarantee model, and is it better for the merchants fraud prevention in the long run?

Ravelin's CFO and co-founder Nick Lally explains.

Cardholder protection

A chargeback is the result of the process by which a customer disputes a transaction with their bank. Customers who make purchases with credit cards are legally protected by rules which the card schemes enforce.

Disputes give consumers the right to file a complaint if they suspect any kind of unauthorized transaction on their card. Once the dispute is filed, the banks will then investigate the claim, with the Merchant having the opportunity to submit evidence in their defence.

If the merchant "loses" the claim, a chargeback results and the bank will recover the funds from the merchant via their acquiring bank and the consumer will get their money back. On top of this there are further fees handed down to the merchant for processing a transaction that turns into a chargeback.

All of this means that chargebacks can then become very costly very quickly for the merchant.

The promise then of a chargeback guarantee model is very tempting. No more chargebacks and no more stress? Is this too good to be true?

What's the chargeback guarantee model (CBG)?

Under the chargeback guarantee model, the fraud solution provider guarantees to pay the chargeback costs for any transaction they recommend to accept that results in a chargeback due to third party fraud.

When choosing a fraud prevention provider it’s easy to focus only on the cost of chargebacks. The impact, however, is much greater. All fraud prevention systems have four costs; chargebacks, blocked good orders, the cost of the solution itself, and the people required to run it.

The promise of a CBG vendor is that all of those costs are bundled into a single predictable cost that is a percentage of the revenue. For many small businesses who can never justify a fraud team, this is a compelling offer. Also if your businesses is more sensitive to chargebacks than declined orders this is also a strong proposition.

As a consequence most of the clients that go for chargeback guarantee products are small ecommerce sites and/or merchants that process sales of high margin goods and services.

Misalignment of interests

When it comes to larger businesses the benefits become less compelling. Here’s why.

If you consider the four costs that are built into a fraud strategy, two of them are in opposition – declined good orders and chargebacks. We all know that to stop all chargebacks requires a higher decline rate even with an accurate detection system like machine learning. Technically it is called precision and recall.

For a CBG vendor to maximise their margins they need to minimise their chargebacks. To do this they have to increase the number of declined good orders. There is very little incentive for them to take on the risk as they wear the liability. While in certain businesses this might be OK, in many more it is a difficult conversation to explain why good customers have been unnecessarily blocked due the the exposure of an external supplier to cost risk.

The true cost of declined orders is also a difficult one to measure. There is the immediate loss of an order but there is also the potential of putting the lifetime value of a customer at risk. For businesses in highly competitive spaces this is a real risk as a good customer goes elsewhere to satisfy their order. Having a fraud vendor that is incentivized to decline can be more costly than immediately realised.

Giving up agency and losing trust

Another feature of the CBG model is the merchant giving up control of visibility and limits the merchants ability to gain deeper insights to fraud. CBG users have complained about a lack of control and insight. Getting accept/reject messaging, while uncomplicated, teaches a business little about the fraud risk it faces.

For many merchants this might be fine. For smaller businesses or those with low volumes understanding the nature of the fraud threat it faces and being able to engage on the prevention methods in place is not a priority. For larger businesses though, analysis and strategy are key to understanding not simply the current threat but also the emerging ones . After all, chargebacks are only a part of the risk that online businesses face.

It’s also worth noting as mentioned a few times, that the guarantee only relates to chargebacks that are as a result of third party fraud. Therefore, friendly fraud or other types of fraud are still the responsibility of the merchant.

So the notion of never seeing a chargeback again... well, is sadly not the case.

In fact, a merchant should also be resourced for a chargeback dispute process with their CBG vendor as we all know the reason codes on declines and chargebacks are rarely clear and never consistent.

At the heel of the hunt, merchants wants maximum acceptance and a CBG vendor wants minimum chargebacks. It then becomes a constant battle.

Chargebacks aren’t the only problem

As any business will know the problems with fraud unfortunately don’t stop at chargebacks. It’s likely that there will be account takeover, promo abuse, friendly fraud and more that your chargeback guarantee does nothing to prevent. Merchants will need to pull in additional technologies to strengthen business security – and then it’s maintaining multiple systems rather than just working with one fraud prevention company.

If you are a merchant that is trading at any volume or size then you should be looking at investing wholly into your fraud prevention solution then you should be looking at minimizing chargebacks and improve transactions across your whole dataset with all transactions to be treated equally.

Tackling the overall fraud problem once and for all

Our goal at Ravelin is to build trust, reduce chargebacks, and have a high acceptance rate because we know our models can predict which transactions will be good and bad before the sale even happens.

Working with a fraud prevention provider that is judged on accuracy rather then using a CBG model means that the merchant will have higher acceptance rates and higher volumes of transactions.

We believe it is much better to work in partnership with a fraud vendor on the same goals of maximal acceptance and minimised chargebacks in line with the goals of the business. Adopting a holistic fraud solution that looks after all the transactions means greater volume of sales, reduction of false positives, insights and analytical reporting, lower chargebacks and end-to-end management of overall fraud.

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