What is friendly fraud? A guide for small business owners

The thrill of landing a sale can turn sour when customers later dispute their charges for illegitimate reasons. In recent years, friendly fraud has transformed from an occasional annoyance to a major challenge that eats into small businesses’ profitability.

Unlike third-party fraud, where a shopper uses another person’s information to make a transaction, friendly fraud is committed by customers themselves. Despite its name, the term ‘fraud’ can 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 – making these incidents tricky to identify and address.

So, what causes a friendly fraud chargeback, and what can you do to protect your business from fraud? Here’s what you need to know about how to deal with friendly fraud.

How does friendly fraud happen?

Also known as first-party or chargeback fraud, friendly fraud occurs when a customer pays for a product or service using their credit card but then later contacts their bank or credit card issuer to dispute the charge.

They may claim they did not authorize the transaction or that the product or service was not as described, taking advantage of the credit card chargeback process designed to protect cardholders from scams, fraudulent companies, and credit card theft.

But first, 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 (for example, if it suspects fraud or an error). But the chargeback process is more commonly initiated by the customer themselves for these reasons:

• 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) 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 that:

• They never received the product when they actually did.
• The product was defective.
• You charged them twice.
• They didn’t approve the transaction.

What drives friendly fraud?

Financial pressures and overall economic downturns can cause customers to raise chargeback disputes for purchases they willingly made. Customers may change their mind after making a purchase and contact their card issuer to do so. They may also resort to friendly fraud to avoid paying for items that are out of their budgets.

However, in some cases, friendly fraud can occur without any malicious intent, such as in the examples 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. For example, they may be confused about return policies or have genuinely forgotten they made the 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 instead – while being completely unaware that this is an illegitimate reason for a chargeback dispute.

The data supports this trend: 72% of cardholders view filing a chargeback with their bank as a valid alternative to requesting a refund directly from the merchant, while 75% of respondents see the two methods of dispute resolution as equivalent.¹

Misunderstandings during transactions

Customers may be confused about a transaction when reviewing their statements. For example, a shopper might see a merchant's billing descriptor that differs from the store name they recognize and assume the charge is unauthorized. This can prompt them to initiate a chargeback with the card issuer instead of seeking clarification from the merchant.

Free trial abuse

With more services and subscriptions offering free trials to reel customers in and lock in recurring revenue, businesses are seeing more cases of free trial abuse. Customers might sign up for a free trial, forget to cancel before it converts to a paid subscription, and then dispute the charge.

The impact of friendly fraud on small businesses

Whether friendly fraud happens deliberately, maliciously, accidentally, or unknowingly, the results can be disastrous for small businesses. They suffer from:

• 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. On average, merchants pay $3.60 for every dollar lost to friendly fraud.¹
• Damage to their reputation and credibility. Repeated chargebacks can damage a merchant’s reputation, leading to negative reviews and reduced customer trust.
• The 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, which can eventually lead to the termination of your merchant account.
• Inventory loss. Each chargeback also means the loss of inventory that has already been shipped to the customer.

It’s clear: having a robust friendly fraud prevention and risk management strategy in place is a must – especially for small businesses that may not have the resources to absorb such setbacks easily.

How to prevent 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.

How businesses can reduce 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. No matter what communication channel you opt for, 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 later.

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.

Best practices for managing chargeback scenarios

While the best way to resolve friendly fraud is to avoid it in the first place, it can still occur to the most prepared merchants. Here are some tips on how to tackle fraudulent chargebacks:

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

Keep accurate records of customer interactions to help you resolve any disputes. Once a chargeback has been filed, your payment processor will send you a notification. 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, signed invoices, email correspondence, product descriptions, receipts, or a customer signature.

Thoroughly investigate each friendly fraud chargeback. Closely examine the details of the transaction and the customer’s claim. Look for discrepancies in the customer's story compared to the data you have. This might include checking IP addresses, delivery addresses, and past interaction histories to identify any patterns or inconsistencies.

Engage directly with the customer. Reach out to the customer as soon as you receive notification of the chargeback. A direct conversation can sometimes clarify misunderstandings or resolve issues more amicably. This approach can also help you gather more insights into the reasons behind the chargeback, which can inform what evidence you gather.

Choose a payment provider that specializes in chargeback fraud prevention. Opt for a payment processor that offers advanced security features to help you securely accept payments. These providers should have tools to detect unusual transaction patterns, verify customer identities, and implement strong authentication processes.

How to help protect your business from friendly fraud

The potential risks of friendly fraud are massive: damaged reputation, lost revenue, and loss of product – not to mention the time and cost spent on disputing claims, producing documentation, and paying chargeback fees.

The best way to resolve costly chargebacks is to prevent them from happening in the first place. Good customer service, accurate product information, and accurate data and analytics are foundational. PayPal’s Fraud Protection Advanced can also empower you to stay one step ahead of the fraudsters by detecting ever-evolving fraud techniques with machine learning.

If friendly fraud does unfortunately happen, 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. For eligible transactions, PayPal’s Merchant Seller Protection, we may cover your loss, even if you lose the chargeback.²

Learn more about using PayPal for fraud management.