E-commerce is one of the fastest growing sectors in the Indian economy. A joint study by ASSOCHAM-Deloitte estimated that the Indian e-commerce market may reach $16 billion by 2015, growing at a CAGR of 37%. This growth is fuelled as businesses are increasing efficiencies in demand and supply and diminishing entry barriers. With e-commerce being the new buzz word in the country, it is important to understand some of the risks involved. Fraud is one of the biggest risk these companies face. A CyberSource study suggests that 1% loss of total revenue is due to fraud, large enough to require resource allocation.
There are 3 categories of frauds in e-commerce, each with distinct and multiple Modus Operandi.
- Buyer side frauds (fraudulent claims, chargebacks and abuse of services).
- Merchant side frauds (non-fulfilment, selling counterfeit, cross platform frauds). Cases of money laundering and abuse of online marketplace transactions have also been observed.
- Cyber Security challenges (Account takeovers (ATO) and identity theft).
The seriousness and the damage caused by these frauds – MarkMonitor in 2013 estimated counterfeit goods sold online at $350 billion worldwide. Losses caused by payment card frauds in 2013 is estimated at $14 billion with 43% of all fraudulent claims being chargebacks.
These figures show systemic inefficiencies (and the exceptional unmet demand – in the case of counterfeit/infringing goods, some people purchase these products with full knowledge). The counterfeit goods market’s lucrativeness lies in lack of close substitutes and the ability to bridge this demand with low risk and high benefit. Branded items ranging from smart phones to phone cases are replicated and sold at a fraction of the cost of an original.
Consider an example of a seller selling a counterfeit product, indulging in a fraud scheme with no intention of fulfilment and the case of a fraudulent buyer who intends to place a fraudulent chargeback. In the case of replicas, these frauds are committed when the product quality prima facie cannot be discerned easily by most buyers. The marketplace expects the free market forces will identify such fraudsters and after suffering a reputational damage, these fictitious players will be out of business.
Why do such things happen again and again?
The barriers to enter the market are almost nil. The requirements for registration are an email id and a credit card. In the case of a seller, a bank account to which the earnings are to be credited is an additional requirement. The identity assumed online doesn’t have to be the person’s real identity. There are enough resources online to generate temporary email ids, credit card numbers and many other free tools to mask the person’s identity.
The cost structure incentivises fraudsters to participate on the platform repeatedly. The cost of the hardware used as well as the internet is fixed in nature. Participating multiple times helps spread this cost over those multiple participation.
The risk benefit ratio is skewed with rewards being pure profits for the perpetrators and no real consequence of being caught. The large costs of security and law enforcement following up outside the marketplace is itself a deterrent for the companies to follow up. This leaves the platform vulnerable to recurring incidents by these fraudsters. The initial cost of identification itself is very high.
As a result of this the market experiences the following.
At a macro level, asymmetric information and previous experiences can cause partially informed buyers to stay away from the entire range of products, thereby damaging the market-system. Marketplaces which are sensitive to customer experience bear the cost of bad customer experience by compensating buyers. They are able to retain customers by incurring this cost.
There is also another element of exposure. Marketplaces in which such transactions have occurred, the risk is entirely borne by the online marketplace. Lawsuits have been filed against Alibaba for allowing such transactions to take place.
Due to the existence of many players, such losses have a spill-over effect where financial institutions and other players pay a price directly and in terms of opportunity cost.
These are risks that accrue directly by virtue of transactions on the marketplace. There is another element of risk which accrue due to indirect causals. Government policies also have an impact on the e-commerce business. Given the nature of the business where transactions can occur online between two parties without any physical verification of identity and transaction, there are instances where the platform is misused to transfer money. The actual transaction may take place in another form, but the money flows could be done through these platforms. There are countries with closed capital accounts which place a restriction on the amount of foreign currency that can be held by the general public. The demand for this foreign currency gives rise to a black-market for the foreign currency. The flows of the foreign currency could take place through these marketplaces with the payment of the local currency taking place outside the platform.
Considering this changing landscape, it is necessary for a business to calculate its profit optimizing point between the cost of anti-fraud review and loss due to frauds. The role of fraud has been significantly underrated in economic analysis. Lack of adequate understanding and accounting for fraud dents the ability of the marketplace to function at an optimal level.