What is friendly fraud? A guide for small business owners

Friendly fraud occurs when a customer pays for a product or service using their credit card, but then later contacts their card issuer to dispute the charge for an illegitimate reason. Also known as first-party or chargeback fraud, in a friendly fraud scenario, a customer disputes a legitimate transaction with their bank or credit card issuer, claiming that they did not authorize the transaction or that the product or service was not as described.

Friendly fraud differs from traditional third-party fraud because, instead of using another person’s information to make a transaction, this fraud is committed by customers themselves. But despite its name, the term ‘fraud’ can actually be a misnomer when talking about this kind of chargeback claim. While the claims themselves may be illegitimate, they can happen for genuine or accidental reasons and without malicious intent.

So what causes a friendly fraud chargeback, and what can your small business do to reduce friendly fraud? Here’s what you need to know.

How friendly fraud occurs

Friendly fraud relates to the credit card chargeback process, designed to protect cardholders from scams, fraudulent companies, and credit card theft. What is a chargeback? It’s a refund initiated by a bank or credit card issuer on their customer’s behalf.

Occasionally, a bank initiates a chargeback unprompted by the customer (if, for example, it suspects fraud or an error). But the chargeback process is more commonly initiated by the customer themselves, for example, if:

• Their card has been stolen and someone is making fraudulent purchases.
• They’ve been refused a refund on an item or service that they think is owed to them.
• They (or a family member such as a child or teenager) has purchased something accidentally.
• They don’t recognize the business name used on a billing statement.
• They’re trying to get goods and services for free.

There are two types of friendly fraud chargebacks: accidental and intentional. An accidental chargeback happens when a customer disputes a transaction due to a mistake or a misunderstanding, such as not recognizing your company name on their credit card statement or genuinely forgetting they’ve made a purchase.

Intentional friendly fraud chargebacks, on the other hand, occur when a customer deliberately initiates a chargeback for a valid transaction, such as fraudulently claiming they never received the product or that the product was defective.

Some common intentional friendly fraud scenarios you may experience in your own small business include:

• A customer claiming they didn’t receive your product or service when they did.
• A customer falsely claiming you charged them twice.
• A customer insisting they didn’t approve the transaction when they did.

Reasons behind friendly fraud

Cases of friendly fraud have risen in recent years. This is due in part to the rise in online shopping and card-not-present transactions. Illegitimate chargebacks are also known to increase in economic downturns.

Financial pressures can cause customers to raise chargeback disputes for purchases that they have willingly made. Customers may change their mind after making a purchase and contact their card issuer to do so. But in some cases, friendly fraud can occur without any malicious intent, such as in the cases outlined below.

Unintentional actions by customers

Accidental friendly fraud is when a customer unknowingly makes false claims to their card issuer due to innocent mistakes or misunderstandings. Examples of unintentional friendly fraud include confusion about return policies or a customer genuinely forgetting they have made a purchase.

Dissatisfaction with products or services

Some customers may initiate a chargeback because they are unhappy with a specific product or service. Instead of pursuing a refund through the proper channels, they may choose to dispute the transaction with their card provider and may be completely unaware that this is an illegitimate reason for a chargeback dispute.

Misunderstandings during transactions

Customers may be confused about a transaction when reviewing their statements. This can prompt them to initiate a chargeback with the card issuer instead of seeking clarification from the merchant.

Impact of friendly fraud on small businesses

Whether friendly fraud happens deliberately, maliciously, accidentally, or unknowingly, the results can be equally disastrous for small businesses when it comes to lost product, lost revenue, and higher payment processing fees.

Financial losses and chargeback fees: When you deal with a chargeback, you may be subject to additional charges from card issuers that can add up to more than twice the original transaction amount.

Damage to merchant reputation and credibility: Repeated chargebacks can damage a merchant’s reputation, leading to negative reviews and reduced customer trust.

Potential risk of merchant account termination: Whether you win or lose a chargeback request, it will affect your chargeback ratio, which determines your standing with credit networks. The more chargebacks you encounter as a seller, the higher the likelihood you’ll be flagged as a higher-risk merchant, something that can eventually lead to the termination of your merchant account.

Having a robust risk management strategy in place is a must.

Preventing friendly fraud

Here are a few ways you can work to help reduce online fraud in your own business.

• Improve communication with your customers and provide exceptional customer service.
• Provide email confirmations, package tracking, and delivery notifications.
• Consider extending your return policies.
• Be transparent regarding shipping, cancellation, and return policies.
• Verify customer identities for high-risk transactions.
• Look for patterns in buying habits so you can spot any unusual activity.
• Provide honest and accurate product descriptions.
• Be prepared to challenge friendly fraud when it happens – do not accept chargebacks as just the cost of doing business.

For more information read our guide on how to reduce point of sale fraud.

Mitigating friendly fraud incidents

To mitigate friendly fraud, businesses are turning to a range of tools and strategies. Many of these aim to resolve customer disputes before they have the chance to turn into a chargeback, solving disputes and ensuring customers are satisfied with their purchases and services right from the get-go.

Provide exceptional customer service

Being available and responsive not only helps you resolve customer issues or concerns proactively, but building up a good rapport with your customers also means they’ll cut you some slack further down the line should any problems occur.

Consider using live chats or social media to help you respond to your customers. However, you choose to communicate, keep detailed records of any interactions as these will prove vital for future chargeback responses.

Resolve customer disputes proactively

Having a good relationship with your customer can help resolve chargebacks once they happen. Get in touch with the customer to try to settle the dispute with a refund or exchange. Even if you fail to resolve the issue, you may gather important information or evidence you can use later on.

Collaboration with payment processors and issuers

Payment processors can provide valuable insights into the reasons behind chargebacks and offer fraud management tools and services that can help with friendly fraud prevention.

Chargeback management best practices

While the best way to resolve a friendly fraud chargeback is to avoid one in the first place, sometimes they can’t be avoided. For this reason, it’s always considered a best practice to monitor and analyze your chargeback data. This involves tracking the number and types of chargebacks received, identifying trends and patterns, and establishing their root causes.

When you are armed with the reasons behind chargebacks, you can spot patterns and take all the necessary steps to prevent them from happening in the future.

Another best practice is to keep accurate records of customer interactions to help you resolve any disputes. Once a chargeback has been filed, your payment processor will notify you. You can either accept the chargeback or contest it. If you contest it, you'll need to respond by providing evidence that supports the transaction, such as proof of delivery or a customer signature.

When it comes to disputes, the quality of your evidence is key. When you receive notification of a dispute, provide all the evidence you have as quickly as possible. Evidence can include proof of delivery, signed invoices, email correspondence, product descriptions, and receipts.

Safeguard & protect your small business

Friendly fraud can damage your reputation and your bottom line. Friendly fraud costs businesses money both in reversed transactions and loss of product. Add to that the time and cost involved in disputing claims, producing documentation, and paying chargeback fees, to say nothing of the cash flow issues that may arise.

The best way to resolve costly chargebacks is to prevent them happening in first place. Good customer service, accurate product information, and accurate data and analytics are crucial. Not sure where to start? PayPal can help your efforts to stay one step ahead of the fraudsters. Our Fraud Protection Advanced is an adaptive machine learning solution that helps enable merchants to detect ever-evolving fraud techniques.

If you've been notified of a chargeback, PayPal’s fraud prevention technology can help you sort it out. We'll provide you with the relevant transaction details and walk you through the steps for submitting information to the credit card company.

We may ask you to provide the information needed to help you resolve the chargeback. If you are eligible for PayPal’s Merchant Seller Protection, we may cover your loss, even if you lose the chargeback.