Do you know where your risk losses are? As an industry, we can immediately grasp the benefit and value of the Payment Facilitator model. We can examine, cipher and build the mathematical equations around the cost/benefit of:
- Expedited on-boarding
- Value of aggregated funds
- Reduced cost of signing and supporting
- Increased sales funnel due to expanded MCC’s
We can also look at the payment eco-system and calculate the profound effect and benfits the Payment Facilitator model has had on all participants:
- Card Brands – expanded acceptance at traditional check and cash locations
- Processors – increased merchant and transaction counts; increased sales volumes
- Merchants – increased sales from the new payment medium
What we are minimizing, or perhaps overlooking all together in the value chain formula, is the shift in the type of loss category experienced with traditional direct merchant portfolios as compared to a Payment Facilitator operating sub-merchant model. In traditional direct portfolios, loss categories that skew to the high end of the scale typically include bankruptcies or other financial interruptions, merchant/cardholder collusion/bust out schemes and cardholder fraud that results in Chargeback losses. The common theme of these loss categories – they are event driven and typically unpredictable.
Further compare and contrast of traditional direct merchant portfolio losses to those of a Payment Facilitator operating model bring the following observations to the forefront:
Traditional direct merchant portfolios measure loss across category types. The following categories of risk loss are examples of the hardest to predict (and generally most costly to recover ). Losses in these categories can contribute high dollar impact with little to no recovery against write offs.
- Trailing liability for Cardholder Chargebacks – Merchant funds are typically released well before any Cardholder liability appears – fraudulent or not. in most situations, only high risk merchants and new businesses (for a period of 90 to 120 days customarily) are reserved – especially in a brick and mortar environment and certainly not to the fullest extent of liability. Chargeback liabilities trail, in some cases, in excess of 180 days from the original transaction date. Outside of reserving against typical MCC performance or creditworthiness of the merchant, chargeback losses are hard to predict – especially in the case of cardholder fraud.
- Merchant cash flow Interruption – Supply chain disruptions and raw material shortages, aging receivables, lack of inventory – all of these factors can temporarily impact a business’s cash flow or further – throw the company into bankruptcy. Again, this loss category is hard to predict and manage; dollar losses accumulate quickly and are minimally, if ever recovered. Staff and legal investments are also extensive. Not to mention the trailing chargeback impact if orders to clients are not fulfilled.
3. Merchant / cardholder collusion / bust out schemes – In direct merchant portfolios, anomalies involving cross fraud between merchants and cardholders are often not flagged until the landslide of chargebacks has already begun. At recognition, the parties have scattered leaving behind in many cases fraudulent identities leaving no recourse.
- By contrast, when leveraging the operating modality of Payment Facilitator technology, risk losses can swing to different contributing categories – a few in example below. What is intriguing – by the very nature of a Payment Facilitator operating model – these risk categories are naturally mitigated and planned for in the technology.
- Business Owner Identify Fraud – this loss category is minimized with extensive KYC at on boarding of merchant application; coupled with frictionless underwriting and auto scoring systems, these types of losses can virtually be eliminated.
- Newly established businesses (predominantly eComm MIDs) – one and done scams which plague the industry can be solved with back office risk investigation levers that are integrated into various Payment Facilitator operating modules. Transaction factors and velocity checks authenticate cardholder activity to historical patterns.
- Cardholder chargebacks – normal and customary Chargeback activity is naturally “reserved” as a natural by-product of the 14+ day rolling summer chant deposit transition period due to the process of sub-merchant deposit aggregation.
The common category (and certainly a focus that deserves our collective attention to reduce merchant impact) shared between the two portfolios alternatives is chargeback liability.
Diving a bit deeper into this risk category, let’s examine the cost of a chargeback to a merchant. According to The Fraud Practice, (Source: http://www.fraudpractice.com/fl-paychargeback.html) a chargeback liability example can be demonstrated as follows:
Total Sale = $100.00
Margin (22%) = $22.00
CreditCard Issuer Interchange & Acquirer MDR (3.5%) = $3.50
Net Profit = Margin – Credit Card Issuer Interchange & Acquirer MDR
The merchant will make $18.50 from this one sale, if it ends up as a charge-back, it will cost them:
Net Profit = $18.50
Consumer Refund = $100.00
Charge-backFee = $25.00
Net Loss to Merchant = Net Profit – (Consumer Refund + Charge-backFee)
The merchant will have lost $106.50 on this order. That means they would have to sell 4.8 more orders at this same amount just to make up this one loss. This example does not even take into account all of the merchant’s costs, such as overhead and processing fees. It also assumes a very low charge-back fee — if they are doing e-commerce and are considered high risk, the charge-back fee could be $100 or more.
As we swing and blend our processing methodologies from merchant direct to sub-merchant solutions over the next few years, we have the capacity to swing the categories of risk loss as well. We will be able to measure the bottom line contribution of the new categories of loss that are more predictable and manageable via risk and underwriting automation. We will also grow to understand the full effect of the math of saved staff time, collection and legal expenses associated with restitution and loss management of the risk categories we predominantly chase now.
In the interim, to measure the full effect of Payment Facilitator risk mitigation, ask yourself these questions – Am I including the appropriate values in my monthly analysis and metics? Does my P/L demonstrate the positive contribution of risk category shift? Am I including all of the expense reductions associated with back office items? Am I mitigating Chargebacks against the appropriate cost/benefit model for each merchant situation?
Be sure you are capturing all of the upsides and impacts in your financial and operating results; look at your procedures – do they reflect the appropriate course of action based on value of sale versus chargeback? As you make progress along the way, we would love to hear of the results you achieve as you swing your risk and impact your bottom line with expense eliminations and loss write off reductions.
— With a career spanning 30+ years, Floyd has held EVP and COO roles with various financial services organizations, including industry leaders ACS, now a Xerox company, and TransFirst. Floyd led the design, development and integration of the operations, on boarding and risk management systems to support Austin, TX based SecureNet (now a WorldPay company) in their rollout of mobile and omni commerce. Most recently, Floyd was the COO of Clearwater Payments , a Dallas, TX organization delivering flexible consumer bill payment solutions to a variety of industry segments.