The growing threat of first-party fraud and its impact on the payments ecosystem

What is first-party fraud? 

First-party fraud, often referred to as friendly fraud in the e-commerce industry, occurs when a cardholder disputes a legitimate purchase with their bank, triggering a fraud chargeback. In reality, the cardholder, or possibly someone with access to the card such as a family member, may have made the purchase. This type of fraud significantly impacts merchants, with Mastercard estimating that the annual cost is approximately $50 billion. ⁽²⁾ 

What are some examples of first-party fraud? 

First-party fraud occurs when a consumer misuses or manipulates the chargeback and dispute process for personal gain. Here are some examples:  

1. Cancelling a subscription via the issuing bank 

The scenario: A consumer subscribes to a streaming service with a monthly fee. After using the service for a few months, they decide to cancel. 

First-party fraud in action: Instead of canceling directly through the streaming service's website or consumer support, the consumer contacts their bank to dispute the monthly subscription charges, claiming they never authorized them. 

The outcome: The bank processes the dispute as a chargeback and the streaming service loses the revenue for the disputed months and may also incur additional chargeback fees. 

2. Disputing recognized charges

The scenario: A consumer makes a purchase from an online retailer and receives the product. After using the product for a while, they decide they no longer want it but are outside the return policy window. 

First-party fraud in action: The consumer contacts their bank to dispute the charge, claiming they do not recognize the transaction. 

The outcome: The bank initiates a chargeback; the retailer loses the revenue from the sale and the consumer retains both the product and the refunded money. 

3. Disputing services provided  

The scenario: A consumer books a non-refundable hotel stay through a travel website and completes their stay. 

First-party fraud in action: After their stay, the consumer contacts their bank to dispute the charge and claim they never stayed at the hotel, or that the booking was made without their knowledge. 

The outcome: The bank issues a chargeback; the travel website or hotel loses the payment and the consumer scores a free holiday. 

4. Unauthorized purchase claim

The scenario: A consumer buys an expensive tech tool online and receives it. 

First-party fraud in action: They then contact their bank and dispute the transaction, claiming their card details were stolen and used without their authorization. 

The outcome: The bank issues a chargeback, the online retailer loses the money, and the consumer keeps the gadget without paying for it. 

5. Non-receipt claim for service 

The scenario: A consumer hires a freelance graphic designer for a project and pays upfront. 

First-party fraud in action: After the project is completed and the consumer has received the deliverables, they dispute the payment with their bank, claiming they never received the services. 

The outcome: The bank processes the chargeback, and the designer loses the payment for their work despite having delivered the services as agreed. 

Spot the common theme? In all these examples, the consumer initiates a dispute or chargeback through their bank rather than resolving issues directly with the merchant, often with the intention of benefiting financially while the merchant bears the loss. 

Why is first-party fraud so prevalent?  

According to a recent Mastercard chargebacks trends and outlook report, ⁽⁴⁾ 75% of digital goods merchants’ card-not-present fraud is estimated to be the result of first-party fraud. Further reports indicate that nearly half of all Gen Z consumers have admitted to engaging in first-party fraud. ⁽⁵⁾ There are a few reasons for this.  

First, the boom in e-commerce and the rise in digital transactions has led to a surge in transaction confusion. Naturally, the increase in payment card transactions versus cash payments means more opportunities for misunderstandings. For example, transaction descriptions on card statements don’t clearly identify the merchant, causing cardholders to mistakenly believe a legitimate transaction is fraudulent. In fact, a January 2024 Datos Insight survey showed that 50% of consumers questioned a purchase in the last 12 months and 24% did so because they didn’t recognize the details on their statement. Indeed, what is one to think when they see a $361.55 charge to SYTLEH*3H4029NH on their statement? ⁽⁶⁾ 

Another contributing factor to the surge in friendly fraud is the challenging economic environment we find ourselves. In fact, EY’s 2023 Gen Z Segmentation Study ⁽⁷⁾ noted that the younger generation’s anxiety levels are at all-time high due to cost-of-living pressures. What’s $35 to a major corporation?  

Moreover, young consumers may simply not consider first-party fraud as true fraud, instead a simple “hack” that hurts nobody. ⁽⁸⁾ 

How does first-party fraud affect merchants, issuers and the consumer? 

First-party fraud poses significant challenges across the payments ecosystem, affecting merchants, issuers and consumers alike.  

The impact on merchants  

Merchants are often the most directly affected by first-party fraud. The financial and operational repercussions include: 

• Financial loss   

As previously stated, it has been estimated that first-party fraud cost merchants upwards of $50 billion a year. More specifically still, it has been calculated that every chargeback can result in a total loss of up to 2.5x the original transaction amount. ⁽⁹⁾ 

• Inventory loss 

Direct inventory loss occurs when the goods merchants ship to the consumer are either never paid for or are fraudulently disputed. 

• Increased operational costs 

Increased operational costs refer to the additional expenses incurred by merchants in managing and resolving chargebacks and claims, including staff time, administrative resources and potential legal fees. 

The impact on issuers 

Issuers also face significant challenges due to first-party fraud. These include: 

• Financial risk 

Issuers are at risk of financial losses due to reimbursing cardholders for fraudulent transactions, which can impact their profitability and financial stability.  

• Resource allocation 

Managing and investigating first-party fraud cases requires significant resources, including personnel, technology and time. This diverts resources away from other operational activities and can strain the issuer's capabilities. 

• Policy adjustments 

To mitigate the risk of first-party fraud, issuers may need to adjust their policies and procedures. This may involve implementing stricter verification processes, enhancing fraud detection mechanisms or updating risk management strategies to adapt to evolving fraud tactics. 

At the end of the day, issuers face pressure from multiple fronts: they must comply with regulatory policies and meet consumer expectations for a seamless process, which obligates them to issue chargebacks quickly. 

The impact on consumers 

While the cardholder may seem like the beneficiary of first-party fraud, they too can suffer in the long run.  

• Higher costs 

Increased fraud-related losses for merchants and issuers can lead to higher prices for goods and service. This, naturally, affects consumers' wallets. 

• Stricter verification processes 

To minimize the risk of fraud, businesses may implement more stringent verification procedures, which can make transactions more cumbersome and time-consuming for consumers. 

• Potential legal consequences 

If caught, friendly fraudsters risk legal action and damage to their credit scores and financial reputations, impacting their ability to access financial services and products in the future. 

Effective strategies to mitigate the impact of first-part fraud on the payment’s ecosystem require a collaborative approach.  

Discover how Mastercard is addressing the rise in first-party fraud in our next blog in this two-part series.  

Footnotes: 

1. 2023 Chargeback Field Report, Chargebacks911 and Digital Commerce 360, 2023
2. First-Party Fraud - Help protect your business from first-party fraud, Ethoca, 2024
3. First-Party Fraud’s Big Comeback in Banking and Lending, BankInfoSecurity, 2024
4. Chargeback trends and outlook 2023 Report, Ethoca, 2023
5. Q2 Digital Trust Index, Managing Risk in the Era of AI-Fueled Fraud, Sift, 2024
6. 'Who the heck is SYTLEH*3H4029NH and why did I pay them $361.55?' Taking the mystery out of shoppers’ card statements, Mastercard Newsroom, 2024 
7. 2023 EY Gen Z Segmentation Study, EY, 2023
8. 42% of Gen Z admit to committing friendly-fraud. Here’s how to protect your business, Fast Company, 2024
9. First-Party Fraud: A Merchant’s Guide, Chargeback Gurus, 2023