Medium-size online stores lose 2.5% of revenues to online fraud

The sixth annual survey of e-commerce fraud released by CyberSource Corporation shows that US merchants expect to lose an estimated $2.6 bln to online fraud in 2004, $700 mln more than in 2003. The new estimate beats the prior fraud loss record of $2.1 bln established in 2002.

Though merchants feel they are limiting the rate of fraud loss (this year’s loss rate of 1.8% of sales is statistically level with last year’s 1.7%), e-commerce revenue is growing so fast that a steady fraud rate means ballooning dollar losses. And fraudsters tend to be attracted to higher ticket price items. The median price on fraudulently ordered merchandise in 2004 was $150 while the median amount for a legitimate purchase was $100.

Hardest hit are the mid-range companies, those with annual online revenues between $500,000 and $5 mln. This group says it expects to lose up to 2.5% of its online revenue to fraud, compared to 1.9% last year. Larger companies fare better. Those with revenues between $5 mln and $25 mln experience a loss rate of 1.5%, identical to the year before. Companies with annual revenues greater than $25 mln anticipate losses of 1.1%, slightly less than last year’s 1.3% loss rate.

One other alarming note that emerged in the findings was the estimated fraud rate experienced in international e-commerce. High growth rates outside the US make foreign e-commerce an important initiative for US merchants, but one that brings more risk. Survey data shows international orders are rejected twice as often as orders from North America. Those merchants who accept orders from outside the US and Canada say they reject over 13% of orders just on suspicion of fraud. And among those orders accepted, 3.8% turn out to be fraudulent, a rate nearly 3 times higher than the overall rate.

There is good news in this year’s survey. Electronic commerce continues to grow. Merchants surveyed expect their e-commerce revenues to increase by 39% in 2005. And, on average, fraud rates have slightly decreased. Among all the orders merchants accept, on average, 1.3% turn out to be fraudulent. The average fraud rate in 2003 was statistically similar at 1.4%. In 2004, 50% of merchants complained of fraud rates equal to or greater than 1%, a slight improvement over 2003 where 58% of merchants experienced such fraud rates.

The highest costs associated with the management of fraud are typically loss of potential revenue and wages. A key source of revenue loss occurs when good orders are rejected for fear of fraud. According to the survey, rejection rates during 2004 were nearly 6%, up from 4.6% last year. So for every confirmed fraudulent order, merchants are refusing to accept another 4 to 5 orders on suspicion of fraud. Significant revenue is being left on the table if even a small portion of these orders are valid.

Manual order review and its associated costs are equally threatening to merchant profits. In what should be an automated sales environment, 73% of merchants are manually checking orders today, up 12% from last year. Across all surveyed merchants, the number of orders being manually examined increased by 20%: 27% of all orders were manually reviewed in 2004 versus 23% of all orders 2003. This leads to obvious questions about merchant capability of coping with continuing e-commerce growth. According to the survey, only 21% of merchants expect to increase the size of their review staff in 2005, so greater productivity among order checkers is clearly required.

Merchants’ use of fraud tools is at an all-time high now. In addition to manual review, 82% of merchants use Address Verification Service, 56% use Card Verification Number checking, and 53% use internally-built fraud screens. The number of merchants using commercial fraud screening solutions grew 55% from the year before: 18% in 2003 and 28% in 2004. The median number of tools in use now is 5, and 40% of merchants are using 6 or more. Large merchants are the most likely to invest in automation, with 79% of those with $25 mln or more in revenue having automated order screening systems. Fraudsters will take more than $2.6 bln out of e-commerce vendors in 2004 – a 37% increase over the 2003 estimate. The cost of managing fraud jumped. Merchants are rejecting 28% more orders due to suspicion of fraud. Rates of manual review increased 17%. Merchants are using more tools to combat fraud. Merchants believe that online sales will grow 39% in 2005, but 79% have no plans to hire more order review staff. The rate of fraud, as a%age of online revenues, has not increased from last year. But growth in online sales means increases in fraud losses. International e-commerce continues to be a higher risk, with order rejection and fraud rates up to three times higher than domestic orders.