It’s difficult to pin down exact figures, but in 2004, Forbes magazine estimated that adult industry revenues amounted to $57 billion annually worldwide; $14 billion a year in the U.S. alone. Only about $2.5 billion of that total was attributed to websites, which may or may not jibe with the $35 million a month credit card companies allegedly rake in from pornography. Cable and satellite television reportedly earned $2.5 billion from porn in 2004. According to the New York Times, in 2000 large hotel chains earned about $190 million per yearfrom in-room pay-per-view porn videos. Pay-per-view providers LodgeNet Entertainment and On Command generated as much as another $295 million per month from adult content during the same period, according to Forbes. More recent figures are not easily available, as mainstream companies have learned to camouflage their sex revenue streams deeply within their annual reports, but it seems likely they’ve grown, possibly monumentally.
A prurient fascination with adult entertainment’s filthy lucre has made oft-quoted comparisons almost trite, but they stand anyway:
In terms of revenue, the worldwide adult entertainment industry is larger than professional football, baseball, and basketball combined.
U.S. porn revenue exceeds the combined revenues ($6.2 billion) of ABC, CBS, and NBC.
What’s not quite as well known is that as large as the financial pie is in adult, it could be even larger. Legitimate chargebacks and so-called "friendly fraud" claim as much as one-third of the potential revenue from adult online entertainment – or about $20 million worldwide – according to Marcus Segal, vice president of operations for risk management firm Vindicia (Vindicia.com). Of that one-third, as much as 70 percent is money that is legally owed. "I suspect adult merchants run 4 to 5 percent higher than nonadult merchants in terms of losses due specifically to friendly fraud," Segal says. "Friendly fraud" is a euphemistic term applied to chargebacks initiated by consumers who feign ignorance of credit-card and telephone charges even though they’ve received the merchandise or viewed the electronic content.
The good news is that adult businesses don’t have to take the loss lying down. "It is recoverable revenue," Segal says, and what’s not recoverable is preventable.
Heading the bad guys off at the pass
Segal’s company specializes in helping virtual merchants in mainstream and adult enterprises cut their losses by identifying high-risk consumers before purchases are made. A "smart" software application that "learns" constantly and runs in real-time between the merchant’s shopping or sign-up page and his payment gateway screens potential customers against a variety of blacklists and other fraud-prevention mechanisms to either stop consumers who’ve established a track record as friendly fraudsters or make them provide additional verification of their identity and intent to complete the transaction at hand. Detailed reports provide merchants with information not only about their members and customers, but also about affiliates who may be sending more than their share of deadbeat referrals. The statistics also may be able to give merchants an early "heads-up" about sites headed for friendly fraud trouble because of flaws in concept or design, with a little bit of analysis by Vindicia, Segal says.
If friendly fraud chargebacks manage to sneak through anyway, Vindicia goes to bat for its clients with the card companies and is successful in recovering the disputed funds in about 70 percent of cases, Segal says. In exchange, the company takes a percentage of the money it saves or recovers. Segal calls his company’s fees "found money," because clients would not have seen that revenue without Vindicia’s assistance.
In some cases, the "found" revenues amount to hundreds of thousands of dollars a month. According to credit card company rules for "high-risk" merchants like adult entertainment websites, the number of chargebacks cannot represent more than 1 percent of the total number of transactions. As Segal notes, though, "that doesn’t necessarily mean 1 percent of your revenue. People who charge back run up big bills first. If someone’s going to steal, they might as well steal big. Don’t assume that because your chargebacks are below the 1-percent threshold that you’re only losing 1 percent of your revenue."
He also warns that the likelihood a consumer will charge back a transaction rises as the dollar amount of the transaction increases. Barring probing questions from an indignant spouse, consumers are much less likely to deny they made a purchase of $10 than one of $100.
In addition to the purchase price of whatever was bought, other financial factors come into play when figuring losses, Segal advises. "Chargeback fees can be steep—$25 or more per occurrence, depending upon your bank," and stringent fines can be tacked on top of that if a merchant exceeds the card- or bank-imposed threshold. In addition, there are bandwidth and storage charges associated with the delivery of electronic adult entertainment and man-hour costs attendant upon its creation, maintenance, and updating. Add to that customer service and accounting expenses involved in researching disputed charges and then crediting the consumer or wrestling with the issuer of his credit card, and it’s easy to see why many adult webmasters let consumers play fast and loose with the system instead of fighting back.
"Letting that revenue go is a mistake," though, warns Segal. "Internet commerce in general is all about margins. It’s pennies on pennies. You can’t afford to let 1 percent or 2 percent of your revenue go without a fight, because that 1 or 2 percent actually costs you much more than you realize."
Segal’s words are especially ominous in light of recent statistics from Informa Media and Cybersource. According to them, chargeback fraud is climbing at an alarming rate. Internet merchants as a whole lost approximately $600 million to chargeback fraud in 2003. In 2005, that figure is expected to approach $800 million, and it is predicted to top a whopping $1 billion by 2006—and those are just the direct costs. Indirect losses are impossible to calculate.
Rounding up the strays
One of the reasons Vindicia is so successful at recovering disputed funds for its clients, Segal says, is that its software application collects indisputable evidence from high-risk consumers before it will let them make a purchase. "In essence, they prove they’re really who they say they are and they really want to purchase the material," or they don’t get through the system, he avers. The information, including an IP address and certain personally identifiable data only the cardholder would know, gives Vindicia a "paper trail" to present to the consumer’s credit-card company or bank if the customer suffers buyer’s remorse after spending 11 hours watching Debbie do Dallas, New York, San Francisco, and Hong Kong at a cost of $4.95 per minute. Even so, about 30 percent of friendly fraud cases are stubborn and end up being referred to a collection agency.
That’s where "receivables management" firms like Chicago-based 1st Credit of America LLC (1stCofA.com) come in. Founded nearly three years ago by mortgage industry professional Elie Mellul, 1st Credit’s bread-and-butter income is collections in the medical, financial, and telecommunications industries, but over the past year the company has seen its adult industry contracts grow as content purveyors realize they have options other than bending over for callous consumers. ChargeMeLater (ChargeMeLater.com) was 1st Credit’s first big adult industry account; WTS Bank (WTSBank.com) and Vindicia joined the company’s client roster in the second quarter of 2005.
Mellul thinks one of the biggest hurdles adult entrepreneurs have to overcome in order to get all the money that’s owed to them is their own tendency to buy into society’s notion that adult content is somehow "unworthy" of existing on a commercial plane. "It doesn’t matter what the content is: Porn, adult, it’s irrelevant," he admonishes. "It’s just digital content, and the consumer needs to pay for it. Purchasing adult content on the Web is really no different than purchasing the Wall Street Journal online. If you buy it, you’ve got to pay for it."
Mellul says payments that have been charged back on a credit card remain collectible directly from consumers even after card companies and banks have washed their hands of the dispute. As long as the credit card wasn’t stolen, in the possession of a minor, or otherwise used without the cardholder’s permission, the debt is valid and the merchant can pursue it. Once consumers understand that, collections for the adult industry are in many ways easier than for some other industries. "Adult consumers generally are more well-heeled than average consumers," Mellul reveals. "Their ability to pay typically is not an issue. It’s a little more difficult than mainstream at first because people aren’t used to paying for adult content online, but the debt is collectible, and people know it’s collectible and they will pay" as long as they can be shown the holder of the debt has them dead to rights.
Taking charge
There’s the rub. 1st Credit’s current 30 percent collection success rate in adult is impressive in Mellul’s eyes and those of his company’s clients. It’s also in line with industry standards for mainstream accounts. It could be even better, though, if virtual vendors collected more and better data about their customers. "You have to have proof that somebody owes you money," Mellul says. "If you don’t have proof of debt, you have no claim. The accuracy and integrity of the data is paramount: Garbage in, garbage out. If you give us good data, the debt will be collected."
By "good data," Mellul means personally identifiable information like name, address, phone number, the amount of the sale, where the product was procured, and what the product was. Good data also includes evidence the customer received what he purchased. "Online purchases are no more difficult to track than physical products," he insists. "The more information you can give us about the customer, the better." The customer’s phone number is particularly important, he notes, because in addition to being an excellent key to identity, it’s also the primary contact method for the recovery specialists in 1st Credit’s adult collections division. If a consumer’s really serious about purchasing content on the Web, he’ll provide a telephone number without too much complaint because he actually intends to pay for the merchandise. If the consumer refuses to provide a phone number because he’s ashamed to own his prurient desires, the adult content merchant may be setting himself up for a chargeback if he accepts the purchase, Mellul advises, adding that his company has never found it necessary to go into the salacious details of a purchase with a reluctant payer.
Mellul says his company, too, operates on clients’ "found money," especially since accounts typically are 90 to 120 days past-due when 1st Credit gets them. At that point the debts are still relatively fresh though, he notes, as legitimate debts are recoverable for five to seven years from the date they were incurred. 1st Credit charges what Mellul calls a "pure success fee," meaning the company only gets paid its 25 to 35 percent of a client’s delinquent revenue when it collects. Not surprisingly, the higher the balance, the better the rate of return, he admits, since his collectors work on commission. Although it may take 120 days to recover some delinquent accounts, Mellul says it’s generally clear within 30 whether the consumer is going to pay.
That’s good news for adult entertainment entrepreneurs who would like to reap all the rewards of their efforts, instead of, in essence, giving away one-third of their merchandise for free. "Delinquent" revenues are one thing. "Unrecoverable" revenues are quite another. Even with a renewed outlook on receivables, though, the adult industry shouldn’t allow itself to become complacent.
"A company – any company – needs to be able to control its delinquent receivables," Mellul says. "If it can’t, over time it will put itself out of business. [Adult is] one of the few industries that can’t say what the true size of the market sector is. That tells you it’s growing, and it’s difficult to control delinquent receivables. People get out of the [adult] industry for exactly that reason.
In the mainstream, on the other hand, delinquent receivables portfolios get securitized on Wall Street. They’re bought and sold just like any other financial commodity. At some point at least a portion of the portfolio represents real money in the owner’s hands. Within the next three to five years, I expect to see the liquidation rate of adult delinquent receivables gain a track record like it has in the mainstream."
