When the "big three" third party processors (e.g. Web800, Epoch and iBill) made you end your free trial memberships, did you feel like a frightened little lamb? An angry tiger? Or perhaps a confused deer in the headlights?
At an E-commerce seminar held during the Montreal WebExpo back in May, we saw every emotion that leads straight to hernia and ulcer-land. Rumors flew faster than the Concorde and it was clear that miscommunication was a major cause of much consternation.
Many wondered how the third-party processors could virtually turn their backs on the industry that had built them. After all, though, not without its problems, "free" did entice a number of reluctant porn surfers into their sites.
Unfortunately, credit card companies have found that the Internet accounts for a very small volume of their total sales yet makes for an extraordinarily high volume of chargebacks. Thus, they have declared doing business on the Internet to be a high-risk proposition. And, third party processors have begun to worry about the high number of chargebacks that affect their merchant accounts.
Webmasters are angry primarily for two reasons: First, they can't promise surfers free looky-loo trial memberships; second, and perhaps most vehemently, they feel that fines for chargeback levels have been unfairly passed on to them.
When a charge has gone through someone's credit card and the customer calls the credit card company to have it removed, this is a chargeback. And the bank levies a fee per chargeback. But this isn't what Webmasters are complaining about.
A fine occurs when the total chargeback level of a merchant account exceeds 2.5 percent. The credit card company places this fine on the third party processors (a.k.a. the merchant account). The fines increase each month that the merchant account goes over the acceptable chargeback level of 2.5 percent. So, if a third-party processor routinely exceeds that 2.5 percent level, the fines can get pretty hefty over time. Since credit card companies look at a billing company as a whole even though the billing company's merchant account is comprised of thousands of separate Websites, the fines could be passed on to Webmasters, even those whose own chargebacks don't exceed 2.5 percent. Many Webmasters feel this is unfair.
To help clear the air, we decided to give the big Internet processors an opportunity to tell their side of the story. Epoch System's CEO Jeff Kilbride and Jeff Luedke, the Web800 Vice President of Sales and Support, represented their companies. Through their PR firm, iBill stated that since the company was going through many positive changes, they would be unable to participate.
AVN Online's Sharon Reed conducted the interviews by phone.
How long has your company been in business? How many adult sites do you conduct business with and do you serve mainstream customers as well?
Web800: We recently just celebrated our third anniversary of processing credit cards over the Internet. We're totally adult sites. We currently have over 10,000 businesses that we work with.
Epoch: We've been in business since mid-96: so a little over three years. Because we're going through a trimming process [see the next question], we'll probably be in a range of 4000 sites afterwards. We process adult and mainstream sites. At first we were nearly 100 percent adult, and it's only over the past nine months to a year that mainstream has started to come aboard. We're probably at the 70/30 point now.
Does a site have to have a certain revenue to use your service?
Web800: We do not require new customers to have a certain revenue at all. We would love to help any customer who wants to start a business irregardless if they're really small or very large.
Epoch: For us to work with a site, it must have a $5000 gross transaction volume per month. Last year we went through explosive growth and while explosive growth is good, it can be bad in some ways if you can't control it. So we made the internal decision to cutoff at the 5K level and we announced this back in February and said that we would start cutting people May 15. The reasons we announced it three months in advance was because we wanted to give people the chance to get up to the 5K level. We feel that $5000 in gross profit volume isn't impossible or even hard to achieve if you're seriously committed to your Website and you want to increase traffic and build revenue. We had quite a few do that.
We did this partly because of the 80/20 rule and we found that the guys under 5K were making up such a small percentage of our processing volume. Secondly, they we're the ones routinely falling out of compliance with our compliance department. They weren't taking care of their sites. These were the guys (we felt) who had jumped in the industry to take advantage of making some money on the Net. So they weren't running it as business-like as our guys over 5K.
Do you allow any current clients or new clients with adult sites to use the "free trial" marketing strategy?
Web800: As of April 20, we eliminated the use of free trial memberships.
Epoch: One thing I want to make clear to you is that we have two different types of clients. One client base is the third-party billing option and that's the same generic thing that iBill, Web800 and several other companies offer as a third party billing option. Then we have clients who have their own merchant account who we process for, too. So for the guys who are on our third party billing program (our merchant account and our banking connections) we don't allow free trials for those guys. But if a client comes to us with his own merchant account then we can set up any options they want because it's essentially their banking relationships that they're using.
For what specific reasons did you require sites to end the "free trial?"
Web800: The reason why we stopped offering them was because as a leader in the industry, we realized that the free trials were causing an excessive number of chargebacks and we wanted to be proactive in reducing the number of chargebacks our clients were experiencing. There was a lot of fraud involved with free memberships, although they drove original signups. And, of course, that's going to amount to a higher return rate. Probably a good example of fraud would be if a paysite had a retailer and they were paying per signup, then they could get some credit cards, run them, get the money for the signups, then cancel them again and it wouldn't show up on anyone's billing statement. On a trial membership we found that, in a nutshell, the conversion rate is better if somebody even agrees to pay a small fee - like a $1.95 for three days. The percentages are better for them to renew to a regular monthly membership. Some sites weren't glad the free trials ended, but most of them realized that it was a problem.
Epoch: Regulatory agencies were getting stricter and stricter in this industry. One of the things they were pounding on is the inaccurate use of the word free and not advertising the idea of a free trial correctly where sites would offer free memberships but they wouldn't disclose the recurring nature of the membership. That was the problem. It was a problem for us because we have a very active compliance department and we actually go around to all of the sites that we process for. We would cut clients who had deceptive practices, such as making it impossible to cancel out of the trial membership. You have to look at it from our perspective. It's our banking relationship. Our core business revolves around that banking relationship. If that relationship gets screwed up because people are blatantly not willing to display the correct terms and conditions and tell people what's going on at their site, then they don't really deserve the chance to use our merchant account and our banking facilities.
Did you pass along fines for chargebacks that exceeded the 2.5 percent that the banks gave to you?
Web800: Around April 21, we passed along fines to our Webmasters that had an excessive chargeback rate. Those in excess of the 2.5 percent chargeback rate were fined. So it's important to know that not everyone was fined. Only our clients in excess of the 2.5 percent chargeback rate. We notified the customers of the fines. We sent an E-mail message to our customers and called some of our top customers. We sent them 24 hours before the fines were implemented, but had wished there was more time to notify them. We can't talk about the amount of the fees because that's client confidential.
Epoch: The answer is no. We wouldn't pass them on.
Webmasters typically pay 10 to 15 percent of their profits for third party processing services. Is it fair/legal to pass along chargeback fines to them?
Web800: An important thing to know is our unique pricing model. What we do is charge out the net sale and not the gross sale, which is very different than our competitors. We do not charge a fee for every credit, for every chargeback. We charge on a strict percentage basis to absorb the costs associated with issuing credits and chargebacks.
The normal course of business would enable us to continue this practice, but the level of fraudulent activity in the online adult entertainment industry reached a point where obviously we had to pass the fines along. Also under our billing services agreement under 5B number 4 it stands that any fees, fines or penalties levied by the agent - Visa, MC, American Express or another entity can be passed on. So basically what I'm getting at is with the way our competitive pricing matrix is set up, it's virtually impossible for us to absorb those fines.
Another thing is that's important to note is that 10 to 15 percent sounds like a high number. In the physical world it is, but in the virtual world, it really isn't. What people have to remember is that (for example) if you go to Wal-Mart and you use your credit card, somebody is standing there and there's a signature. You can check a driver's license and basically all of that risk management is done right there and nobody really even thinks about it. But when you're in the virtual business it's quite a bit different. We have to ensure that a person using that card is indeed who they say they are. So there's a fee involved there and that would be under the risk management. We provide over 40 different business functions for each customer including database management and reporting and all that type of stuff and when you add those things in, it's really good.
Epoch: Those fines are based on chargeback levels and we feel very strongly that it's the responsibility of the billing company to prevent fraud. If the billing company is not preventing fraud on the front end, and they get into these fine categories with Visa, then it's the billing companies' problem. We feel that's the cost of doing business for the third-party company. If you're doing what you need to do on the front end, and you're screening out fraud, then you shouldn't have to worry about being fined by Visa on the back end.
The fee for chargebacks is normally $10-25 per chargeback. We pass that fee on to clients and that's in our contract and it's very clear to them.
Did the credit card companies place the adult internet industry on a high-risk status?
Web800: They don't say anything about the industry as a whole.
Epoch: It's still up in the air with American Express. We do have an American Express account and we've been billing them. It's basically the same between American Express and Novus right now - which is Discover. They came out recently saying that they're not going to do any non-product base processing for the Internet. We've heard conflicting stories. We took the American Express billing option down because we don't want people to do initial sign ups now who we can't recur a month later if this Amex story is true that they're going to cut off accounts. It's kind of a safety precaution for us. Cardmembers who have an American Express normally have a Mastercard or Visa also. We'd rather get the MC/Visa sale and not be stuck with American Express account that we can't recur.
Visa and Mastercard came out with a new SIC code, which, yes, elevated the industry to high risk. They're obviously taking steps to control the market because there are a lot of chargebacks in the market. They're very focused when it comes to controlling chargebacks.
Since the free trial ended, have you lost many clients who prefer to start their own merchant accounts?
Web800: We have not lost a significant amount of clients with the elimination of the free trial.
Epoch: When I cruise around the adult chat rooms I'll see people post "Oh we've got this great thing - get your own merchant accounts." The thing is people don't understand the complexity of dealing with your own merchant account if you're stepping into your own merchant account for the first time. When we started out our business we had a 50 - 50 split between guys that had their own merchant accounts versus the ones that didn't have their own merchant accounts. We've seen that drastically decrease on those who have their own merchant accounts.
When you start to build the volume of your site what you don't want to worry about is managing your merchant account. You want to worry about the growth of your site and also if you get into a rapid growth situation you wind up blowing through the cap of your merchant account very quickly. Most guys can only get a $35-40-50,000 account and in some instances they can get a $75-100,000 account if they've got decent credit. If you're serious about your site, you can blow through it in 6 months to a year. And I've seen people do that. We've had clients grow that fast.
Some of our clients go through the struggle of getting credit line increases on their merchant accounts, then finally give up because they can't get the caps they need. So they go to have to go third-party. It's also a matter of (depending on the company that you're processing through) being careful on what kind of fraud you're letting in the account. I've also seen people lose their merchant accounts who weren't processing through us because they weren't taking care of them and the processing company didn't have the fraud solutions in place that were necessary.
Regarding customer service for billing inquiries, does your company handle this or do you hire another company (a fourth party company) do this?
Web800: We handle our own customer service which is open 24 hours, seven days a week.
Epoch: We do it ourselves.
What are the policies for giving credits back to customers when they call in?
Web800: Basically, at our call center, we will issue a credit for some of the reasons such as an underage user, fraud, if an application was declined and they were charged. Or at a Webmaster's request.
We've had complaints from Webmasters about giving credits too easily. In the virtual world, without a digital signature, it's very difficult because of the anonymity of this business. If somebody uses a service, then they call up and say that someone used my card, or my 15-year-old son did, it's very difficult not to issue the credit. We get paid on the volume and we charge on the net amount, so we certainly would want to do the best we could at that job.
Epoch: We've got a whole management system that our customer service reps use online and they're able to give the guy an extra week, or cancel him out on a site as opposed to giving the guy a credit. There are tools that they try to use to bring the credits down if possible. It works in some instances and in others it doesn't. It's a matter of how angry a customer is when he calls in and what his tone is on the phone. If they're basically going to send it to chargeback if we don't credit them, then it behooves everybody to go ahead and give them a credit. You avoid getting the chargeback fee on the backend and you also avoid that 2.5 percent level that you have to deal with Visa.
Adult sites, of course, think that we give credits back too easily. But they look at it from their perspective.
Any Last Comments?
Web800: Web800 is in the business for the long haul. There are certain events going on that have impacted E-commerce business. We have and will implement anything that is for the betterment of processing over the Internet, which will definitely be an advantage for our clients today and tomorrow. We're just really convinced of that. We want to get along with our processors as well as we can. We want to have the lowest amount of returns as we can. We don't want to have to pass on fines - that's our goal.
Epoch: We don't get a lot of confusion on the level of our biggest clients. They understand what's going on from the inside-out. They understand the business and they understand the model. They know what we go through and we know what they go through. It's really a partnership between us and them. They're providing us with an enormous amount of transactions and we're providing them with the ability to make those transactions go through.
One thing is for sure; that the end of the Free trials has been a learning process for everyone on the Net. What you find is that the most vocal people out there bitching and moaning are the least experienced. The more experienced Webmasters stood up and said the free trials were killing us anyway. Those who understand the industry and understand the trends, they're the guys who stand up and say 'hey this is a good thing.'
I've always been surprised at the loyalty of our customer base. Because we've gone through growing pains because of the enormous growth that we've gone through. Over the long run and every show we go to, I've been really pleased with the reaction we get from our clients. If they do have a problem, they feel free to express it to us.
