Fraud is expected to cost online merchants $1 billion this year, including $300 million this holiday season alone, an electronic commerce consulting and research firm says.

Web merchants suffer 30 times the rate of fraud as retail stores do - 3% of sales versus 0.1% - according to the firm, Celent Communications of Boston. Online sellers of more popular items such as books and software are often clobbered with rates as high as 15%, a Celent report says.

For Internet retailers "these losses are particularly deleterious to the bottom line," the report says. "Today, merchants must absorb the large majority of these losses, a significant burden to those struggling to be profitable."

But Internet retailers may not fully realize how much fraud they are experiencing, or may choose to gloss over the problem to secure venture capital.

Internet fraud is more common than retail fraud, according to the report, because it is easier. Perpetrators run the gamut from children playing pranks to sophisticated hackers and organized crime rings. Within minutes they can make multiple transactions with stolen credit cards or phony bank identification numbers. Virtual stores cannot rely on the same security measures that their brick-and-mortar counterparts do, such as checking signatures.

In addition to suffering a higher rate of fraud, online merchants are more vulnerable than retail stores to high penalties for fraudulent purchases. Credit card issuers levy "chargeback" fees of between $10 and $20 when they do not receive payment for a fraudulent Internet sale. Retail stores, by contrast, can avoid chargeback fees when they produce signed card receipts.

Also, credit card companies charge online merchants higher "discount rates," the processing fees for credit card transactions. Web merchants typically pay 2% to 4% per transaction, while brick-and-mortar stores pay 1.5% to 2%. Retailers that experience higher levels of fraud may find banks raising the discount rate even more, or simply refusing to handle their accounts.

But a shift is on the horizon, the report says. It predicts that credit card companies, fearful of losing e-commerce business to other forms of payment and eager to avoid further losses, will step up their efforts to stem fraud and will work with banks and merchants to implement safety measures.

"Assuming that credit card associations become more involved in fighting fraud, we estimate that fraud rates will fall to 2% by 2004," the report says.

However, the report says, the shift may not be visible for at least two years. Online fraud losses will remain at around 3% until then, the report predicts, and merchants and card issuers will have to invest in anti-fraud measures to lower that rate.

The measures could be as basic as manual order checking to spot suspicious or unusual purchases, or single-use credit card numbers. More complex solutions include digital certificates and signatures, and biometric security devices, which identify consumers by physical characteristics.

"Fighting online payment fraud will require significant investments from merchants, financial institutions and credit card associations," the report concludes. "The investment required, although large, is considerably less expensive" than fraud.


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