Risk Assessment

Merchants often believe that their online businesses do not have any risks associated with their operations. This is a common misconception as all CNP (Card Not Present) transactions have a risk often referred to as ‘Pre-Payment Exposure’. It’s important to understand the concept of ‘Pre-Payment Exposure’ before establishing an online merchant facility, as a business model with a high rate of ‘Pre-Payment Exposure’ can lead to a business being required to post security to the Bank and/or the business being rejected by the Bank and Payments Gateway.

What is pre-payment exposure?

A simple way of understanding Pre-Payment Exposure is to imagine purchasing a product online. The amount of time that it takes an online business to deliver the product to you is the Pre-Payment Exposure (The customer pays for the goods before he receives them). Merchants that have established an online merchant facility in the past will have wondered why the Bank was so pedantic about seeing shipping policies and delivery time frames and some Banks even ask the merchant during the application process to specify the number of days that it takes for a customer to receive their products.

Generally speaking if the merchant takes over 7 days to deliver the product a high Pre-Payment Exposure risk is present and security may be required by the Bank in order to process the merchant’s application. You may be wondering why exactly this is and that is a valid thought to have.

Imagine a subscription service whereby a merchant offers a $5 monthly subscription service to their customer. In this instance how long does it take for the customer to receive his/her product? The most common answer to this question is that the customer receives his product as soon as he pays. However, this is not how this is viewed by the Banks.

The customer pays $5 in advance for a monthly subscription. This means that the customer has paid for 30/31 days of service in advance. This also means that the customer has the right to ask for his/her money back in the event that they believe they have not received their product/service in full as advertised within the 30/31 day period.

In this instance the Bank views this as a risk of a chargeback occurring and as such will work out how high the risk is and place a value on it. The merchant will then have the option to post the security and proceed with the subscription business model or look into another business model to reduce the Pre-Payments Exposure.

A very good example of a business model with a high Pre-Payment Exposure is a ticketing event. If a customer buys a ticket in advance to a show that is taking place in six months time then there is a large Pre-Payment Exposure. What happens if the show is canceled? What happens if the customer decides to go overseas before the show? What happens if the customer changes their mind and no longer plans to attend the the event?

Is my business considered high risk?

VISA/MasterCard/American Express etc. are often referred to as “The Schemes” in the Payments Gateway industry. The schemes deem certain industries to be ‘high risk’ – that is that they are more susceptible to having a high chargeback rate – LIST OF HIGH RISK MERCHANT TYPES.

If your online business is a high risk business this does not mean that you will automatically be rejected by a Payments Gateway and/or Bank. The risk of being rejected with a high risk online business model is obviously higher and in most cases where approval is granted a security bond is often requested by the Bank to cover the risk of high chargeback rates.

There are a number of merchants who operate in an aggregation business model and sometimes do not even recognize it. It is important to distinguish if your online business is operating in an aggregation business model as this could also lead to the Bank deeming your online business as a high risk.

What is an aggregation business model?

It is very easy to determine if an online business is operating in an aggregation business model by asking the following questions:

  • Are you offering a service to customers on behalf of more than one company?
  • After you receive the funds from the customer, do you then send the funds to other companies that you are operating for?
  • Is the product(s) that you are offering owned by another party and stocked by another party?

If you answer ‘Yes’ to the above questions then your online business is most likely operating in an aggregation business model.

An example of an online aggregation business model would be an online Wine store that offers a number of different Wines (Penfolds, BirdInHand, Vinrock etc) . The online store would not actually own the Wine bottles themselves nor ship the products to the customers. Instead they would contact the wineries after an order has been made and ask them to ship the order. After the payment from the customer has been made to the online wine store, the online wine store would be required to take whatever service charges they are charging the wineries and then send the remaining amount to the wineries.

Some Banks support online aggregation business models and others do not. If you are looking for a Bank that will support your online aggregation business model or if you would like to speak to someone about how to reduce the risk associated with your online business feel free to call Australia’s Leading Payments Gateway – Merchant Warrior (07) 3166 5489 for honest advice.