FIXZR

The Market for Lemons theory has a lot to tell us about how best to price in the costs of fraud. If we charge everyone for the cost of fraudulent users, good users will be unwilling to pay, but bad users will have no issue with the fees (they’re paying them with stolen money after all!). In time the bad users will drive out the good, the cost of fraud will rise, prices will reflect this and the loss of good users will accelerate quickly to the bitter end. So the question is, if fraud is an unavoidable fact of life, who should pay?

Firstly you must ensure that your user base is no more fraudulent than the population at large, or more specifically, the customer base of your competitors. In that way, while good users may object to paying fees, they have no lower price alternative (from companies with a cost and therefore long-run price advantage over you). Step two is to attract less fraudsters and/or block more fraud. Fairly simple really. Doing this requires deep IP which comes at a high fixed cost. This fixed cost makes achieving scale essential to winning the game and is one of the key assets of large payments players. As fraudsters prey on the weak (and good users abandon the weak) gaining a lead on your competitors quickly is key - a sort of most secure car on the road approach to security versus an unbreakable door approach. Finally you need to start engineering out the cost of fraud, by either passing the cost on to 3rd parties or removing the aspects of your service that enable/attract fraud in the first place.

PayPal lost $9m to fraud in its first year. Fraud prevention is an expensive game to learn, and one that directly affects the bottom line. In tight margin businesses it can be the deciding factor between profit and loss. And in payments, which is a vey tight margin business, fraud is a core business competency. If you operate in payments and are experiencing above average fraud, and cannot pass this cost on to consumers (for the good reasons mentioned above), you should look t merchants to cover the cost. If they are unwilling, and your increased cost of fraud comes with no incremental upside to merchants (e.g. greater customer reach, lower checkout abandonment) - you should perhaps reconsider the game you’re in!