I’ve had the pleasure of working in the e-commerce fraud prevention space since the late nineties and, just as e-commerce has significantly evolved over the better part of two decades, the way merchants battle fraud has changed substantially. Fraudsters have kept merchants on their toes and the industry has responded. We now have a host of new tools, technologies and techniques to assist merchants with a growing fraud problem that always seems to be one step ahead of what the “good guys” can keep up with.
One thing that has remained largely the same, however, is the business model associated with e-commerce fraud prevention. For the most part, service providers have charged merchants a per-transaction or flat-license fee to use their tools, whether they be comprehensive fraud platforms offered by providers like Accertify, Kount or Cybersource, or specialized fraud technologies offered by the likes of iovation, ThreatMetrix or Quova. In this model, service providers don’t have direct “skin in the game” in regards to a merchant’s key fraud metrics, such as chargeback, false positive and manual review rates. However, they are motived to evolve and innovate their services in order to retain customers and grow market share.
The Guaranteed Model
But over the past several years, we have seen a significant departure from the per-transaction model that incumbent fraud prevention providers have traditionally offered. A host of new providers have entered the market with guaranteed fraud prevention solutions that offer a very simple and tempting value proposition: If a fraud chargeback occurs, the provider will cover all costs associated with fraud, leaving the merchant with zero fraud liability. At face value, this seems like a no-brainer for merchants, but, as we’ll explore in more detail, a fraud guarantee often comes with cost and complexities that many may not be ready to swallow.
If we take a look back, we’ll find the concept of an e-commerce fraud guarantee isn’t a new one. PayPal, for example, has offered its “Seller Protection” model to physical goods merchants for many years. Companies like Vesta have offered merchants in the telephony space indemnification from chargebacks for over a decade. And at one point, even traditional insurance companies entered the market with policies to protect online merchants against large fraud losses, an option that most merchants found to be too expensive and riddled with complexities. What was missing from the market were generally-available, guaranteed solutions that could be used by any e-commerce retailer, regardless of what they sold or what payment types they accepted. This is the gap that this new class of guaranteed service providers has filled.
But with a promise to eliminate the cost of fraud chargebacks, why aren’t all merchants flocking to these guaranteed solutions? There are two key reasons: cost and control. The guarantee offered by these providers comes with a price premium that usually costs a merchant between 1% and 4% of the transaction value, in additional to payment processing costs. Obviously, this equates to a significantly higher per-transaction fraud screening cost, potentially costing a merchant many dollars to screen even a good transaction, versus pennies per transaction in the historical models. In addition, guaranteed service providers typically must assume ultimate control over the fraud strategy and decision process, which is something many merchants aren’t comfortable with. Some merchants believe that only they can understand their business well enough to control fraud while ensuring that good customers are never insulted. The notion of giving up control is something that many of these merchants simply will not entertain.
A Full ROI Analysis
The higher cost associated with guaranteed services, however, shouldn’t be looked at in a vacuum, but taken as part of a full ROI analysis. When merchants look at total potential chargeback and operational savings, many will find that the guaranteed service proposition is attractive. For example, merchants have the ability to greatly reduce operational costs by eliminating the need for fraud analysts and modelers, reducing the size of manual review teams and streamlining backend operations that process and fight fraud chargebacks. Coupled with the elimination of chargeback losses, fees and fines, merchants may find that a 2% to 3% fraud screening cost still provides a healthy ROI when compared to managing all fraud support functions in-house.
Although many merchants may, at first glance, still have “sticker shock” over these costs, guaranteed service providers have demonstrated that they can be flexible with pricing, depending on the merchant’s industry, the types of goods sold and the perceived risk. As part of their pricing assessment, providers may ask for historical chargeback data and example transaction data sets in order to ensure that they can manage fraud risk while offering the best possible price. The bottom line is that this new type of model only works when there is a win/win for both the merchant and the provider.
And while cost may be the most compelling driver for some merchants, many also consider three key questions, regardless of the type of solution they are evaluating:
- Do I wish to outsource all fraud functions or keep them in-house?
- What is the cost of change?
- What impact will this have on my customers?
Time will Tell
The answer to these questions, of course, will vary greatly from merchant to merchant. And while the landscape of fraud prevention solutions that exists today is vast, the industry continues to evolve, offering many solutions that address a broad range of risk challenges.
So, will the guaranteed model become the de facto outsourced model when fighting fraud? Time can only tell, but many in the industry are excited about the prospect of what these providers have to offer. For example, in the past three years alone, equity investments in guaranteed service providers have exceeded $225 million. But the cycle for merchants to change providers is often long, so it will most likely take some time before we fully understand how many merchants choose these new services and how effective they are in the long run.
We’d love to hear your thoughts about how this exciting sector is evolving! I’m going to be in Atlanta on February 9th at the TAG Fintech 2017 event. I’d love to meet you there to discuss these and other concerns. I hope to see you there!
And if you need help understanding the ever-evolving fraud prevention market, Glenbrook has helped many merchants and service providers navigate this complex landscape. Please reach out to see how we may be able to help you.