What Every Small Business Needs to Know About Friendly Fraud

The rise of e-commerce has been a lifeline for small businesses, paving the way for innovation and growth opportunities. On the opposite side of the coin, the explosive growth of the digital economy has also created more opportunities for bad actors and cybercriminals looking to defraud businesses and customers alike. However, the fraudulent activity that small businesses are likely to encounter can come from their own customers. We call this friendly fraud, a.k.a. first-party misuse.

Friendly fraud occurs when a cardholder disputes a legitimate purchase, such as a long-forgotten subscription, an accidental purchase, or simply a consumer who doesn't recognize a merchant name on their statement. These disputes result in a "chargeback," where the consumer can call their financial institution to request their funds back and reverse the charge from a merchant.

Has Your Business Experienced Friendly Fraud?

Friendly fraud is a rising experience for small businesses in the digital era, with these incidents having increased anywhere from 20% to 30% in 2022, depending on the market. To better understand why friendly fraud occurs, we need to put ourselves in the shoes of a customer.

Here are the top reasons why customers request a chargeback:

Transaction Confusion: This type of friendly fraud occurs when a cardholder does not recognize a transaction on their bank statement. Common reasons for this confusion relate to unfamiliar billing descriptors or simply forgetfulness.
Family Fraud: Ensues when a dispute is submitted for a valid transaction made – knowingly or unknowingly – by another family member.
Attempt to Obtain Free Goods or Services: Perhaps the most similar to general fraud, this variation of friendly fraud commonly happens with larger purchases. It occurs when a customer purchases a good or service with the whole, usually pre-determined, intent to dispute the transaction.

Small Businesses Are Bearing the Brunt of Friendly Fraud

In contrast to the fraudulent activity in the form of stolen account numbers or identity theft, friendly fraud may seem less sinister – but it's impacting small businesses significantly. According to the 2023 Verifi Global Fraud and Payments report, 62% of merchants report an increase in wrongful disputes in the last year. When a charge is disputed, a financial institution typically kicks off a review process, which ties up money that may be rightfully the businesses. On top of that, time is a precious resource for entrepreneurs, and many don't have the same means as larger companies to combat false claims. Plus, these disputes can increase in a merchant's chargeback ratio, which can impact their bottom-line. In short, these chargebacks are costing them both time and money.

For Kaseedee Pilarz, owner of PilatesBKLYN, a duo of fitness studios in Brooklyn, NY, friendly fraud has become common as she's experienced customers disputing charges after forgetting to use a purchased package membership before it expires. These charges have not only resulted in the loss of the initial funds for the purchased membership package, but the disputed charges also hit Kaseedee with penalty fees. "Friendly fraud has hugely impacted my business, making it hard to predict my monthly profits," said Kaseedee. "I've stopped offering auto-renew membership packages due to how often customers marked the charge as fraudulent, which can make it hard to predict the bottom-line month-to-month."

Visa is Helping to Level the Playing Field with New Rule Change

To relieve the burden of the losses caused by friendly fraud, Visa recently made an impactful evolution to its dispute program. In partnership with merchant advocates, Visa developed a new rule change to help merchants better fight back against first-party misuse.

While intentions may be honest from cardholders disputing the charge, these purchases are not considered unauthorized charges, and small businesses bear the burden of these losses. With this rule change in place, small businesses can now provide additional data or evidence to show that the disputed charge is actually a valid purchase made by the cardholder. The rule change evolves the Visa Dispute program by adding a set of checks and balances to draw a clear and direct relationship between the merchant and cardholder. This change alone can potentially save small businesses over a billion dollars in losses globally over the next five years and is another example of how Visa is advocating for businesses around the globe.

As the digital money movement continues to innovate and expand, risks like friendly fraud will continue to impact small businesses. While chargebacks may occur due to complex customer experience issues, these losses add up over time. Visa is empowering small businesses to fight for the payments they've rightfully earned and is committed to taking a 360-degree approach to combatting fraud.

By Mike Lemberger, SVP, North America Risk, Visa