Online merchants take on much higher risk than their brick-and-mortar counterparts: Nearly 10 percent of all Internet transactions are fraudulent, compared to less than 1 percent of credit card transactions in the physical world, according to a 1999 report by Meridien Research. (The company does, however, expect Internet fraud to drop to below 5 percent in its 2000 report.)
Internet merchants also assume higher penalties for credit card purchases than do physical stores, paying as much as 2.69 percent and 30 cents (compared to 1.5 percent and 20 cents) on every Net-based transaction. Why are online fraud rates so high? Unlike face-to-face transactions, where a signed receipt serves as a contract protecting the merchant against identity fraud, transactions made over the phone or online do not guarantee the card user's identity. This means anyone with access to old credit card receipts or illegal software that generates authentic credit card numbers can attempt to use those numbers to buy online. Even worse, the merchant must assume all the risk in such non-face-to-face transactions.
Julie Ferguson, co-founder and vice president of emerging technologies for e-commerce software company ClearCommerce in Austin, Texas, and founding member and board member for the newly launched nonprofit Worldwide E-commerce Fraud Prevention Network, says the total costs of e-fraud add up to far more than just the cost of goods sold. In fact, merchants are fined for chargebacks, or reversals, against disputed credit card sales. E-fraud costs thus include the cost of the order, bank and card processor fees (including higher discount rates, chargeback fees, fines and even termination of processor service for excessive chargebacks), the expense of manually resolving bad trans-actions and the decline in customer loyalty.