Every wonder why there’s still so much credit card fraud? About 2-3 weeks ago I saw a really documentary on Dateline about online credit fraud, well mostly about identity theft, but still very relevant. It’s what triggered this article. In any case the commentator did a great presentation, and showed how many people get taken. He was even able to show how within a day or so they set up a fake online store to accept stolen credit cards orders on the internet. They did it in a day!
So why is this still happening? Why are stolen credit cards continually used to purchase products when we know how it’s done. Why aren’t credit card companies stopping it cold, or at least bringing it way down?
The answer lies with their motivation and incentives. A while ago I wrote a glowing recommendation on a book entitled “Freakonomics“, where one of the things the book really showed you is that you need to pay close attention to motivations and incentives. And once I started to ponder about the credit card companies motivations, things became a lot clearer. The incentives and motivations just aren’t there to completely remove credit card fraud. There are of course strong motivations to keep it low, but not to completely eliminate it.
Before going into detail, let’s take a look at an example of what happens to us at LandlordMax when someone uses a stolen credit card to purchase our property management software (although it very rarely happens, no one is completely immune to it). Firstly, the fraudster goes online and makes a purchase of LandlordMax. The credit card company authorizes the transaction saying the credit card is valid and has the sufficient funds. Once we get this ok, we then proceed to finalize the transaction and send the customer their product. Everything is looking good and all parties are happy. However within the next few days, more often weeks to months, we receive a notice from the credit company that the transaction they authorized was fraudulent (more often than not it’s because of a stolen credit card). However here’s where it gets interesting, it doesn’t end there, the credit card company then takes back the funds they authorized (remember they told us it was ok to proceed).
So let’s look at the motivations. Firstly they aren’t liable for lost funds. Yes they authorized it, but they aren’t liable, the merchant is. If the card is stolen, the credit card company doesn’t lose a penny, the merchant takes all the risks and losses. Not only does the merchants lose their funds, but you also have to remember that their out of product as well. So for example, if you sold a diamond ring for $2000, not only would you have to give back the $2000 but odds are the diamond ring is nowhere to be found.
Understanding this, it quickly becomes very clear why they aren’t motivated towards a zero tolerance on stolen credit cards. It basically becomes a cost to benefit equation, they have to cleverly balance how much theft they can let go by without people losing confidence in them. To put it in other words, it costs money to detect fraudulent transactions and to be on top of criminals, exponentially more expensive as you get closer to a zero tolerance. What they have to figure out is how much theft is acceptable so that people will still have confidence in their product (and continue to use credit cards) while not paying too much to prevent this fraud. It’s a very fine line to balance. As they get ever closer to zero tolerance their costs go up with diminishing returns.
Remember the key ingredient here is that they aren’t liable for losses they authorized, the merchant is. So their only real motivation is to instill confidence in their customers (credit card holders) that using their credit cards is safe (where they get a percentage of every transaction). They don’t really have a motivation to produce a 100% safe credit card system, at least not until they’re on the hook for the losses instead of the merchants.
Without pushing the point further, don’t get me started about chargebacks. Another one of my favorite pet peeves with credit card companies. If someone ever decides to do a chargeback, of which we’ve had a grand total of 2-3 over the last 4 years which is an incredibly low percentage, not only do the credit card companies take the money back but they also charge you a significant chargeback fee! If you look at their motivation, it’s definitely towards the credit card holders and not the merchants. They have no vested interest in helping you, they don’t lose a cent, they actually make money if chargebacks go through.
So if you take a good look at what motivates credit card companies in terms of protecting people against credit card fraud, its probably not what you expected. Yes they are motivated to keep credit card fraud down, but they are definitely not motivated to completely stop it. It just doesn’t make economic sense for them. Ethically it’s a different story, but unfortunately today the economics is the reality.