The Merchant's Dilemma: Embracing Gen Z's Digital Payment Methods While Mitigating Fraud

Defined by rising prices and growing inflation, the last two years have been full of financial challenges for consumers. While all age groups have felt the pain, Gen Zers have faced particularly difficult headwinds. Research indicates that three-quarters of this generation — those born between 1996 and 2012 — have had to adopt new spending habits as costs have skyrocketed. And though price pressures look to be waning, new transaction technologies and deferred payment plans embraced by Gen Z shoppers — including digital wallets and buy now, pay later (BNPL) — are set to become even more popular.

For merchants, this hankering for alternative payment preferences at checkout, which is shared by tech-savvy members of older generations, presents both an opportunity and a risk. Those that adapt business models and offer payment innovation will be able to tap into a resurgence of spending as the economic storm clouds start to clear. However, going too hard and too fast with tech-enabled transactions opens up new avenues for  “friendly fraud” — i.e., when shoppers make illegitimate chargeback claims to recoup funds they’re not entitled — to wreak damage.

For merchants, winning favor with Gen Z (and digital-minded members of older generations) means plotting a careful path forward, catering simultaneously to shoppers’ desires for greater payment flexibility while bolstering defenses against the deepening chargeback fraud threat.

What Gen Zers Want

Cell phones with physical buttons, dial-up internet, and placing a pizza order over the phone — for many of us, the pre-digital age doesn’t seem that long ago. But for plenty of Gen Zers in their late teens and early 20s, a world without social media and smartphones is entirely foreign. Their complete dependence on technology has fundamentally molded how they live, including their preferences and patterns as shoppers.

Today, these “digital native” consumers are very clear on what they want from a shopping experience: flexibility, convenience, and mobile-optimization. And if merchants can’t meet these demands, they simply walk away — 65 percent of Gen Z admit to abandoning an online cart if their preferred payment method isn't available.

Providing flexible checkout options that align with a seamless, integrated digital lifestyle is now table stakes for e-commerce brands hoping to engage younger customers and older tech-savvy shoppers. With Gen Z alone comprising 40 percent of global consumers, merchants that are unable to adapt to growing expectations for streamlined digital payments risk falling irrevocably behind the competition.

Mitigating BNPL Challenges

Perhaps the clearest sign that shoppers want greater payment versatility is the meteoric rise of BNPL. Point-of-sale short-term lending schemes, which allow customers to split costs from a single purchase into multiple interest-free installments, grew by more than 50 percent last year. Against a backdrop of rising prices, pay-later plans have found favor across all age ranges, however, it’s with cash-strapped youngsters that they arguably resonate most. Strikingly, more than a quarter of Gen Zers say they would forgo buying an item if BNPL wasn't available at checkout.

The flexibility afforded by BNPL is clearly a crowd pleaser, but its convenience also has a downside: it's easy to overspend. Some 40 percent of short-term borrowers fall behind on repayments, raising the specter of illegitimate chargebacks when installments are placed on credit cards. Customers struggling to make repayments — or suffering from buyer's remorse — can simply claim that they're a victim of true fraud, recouping costs via their bank’s dispute mechanism. And because BNPL involves multiple installment transactions, chargeback risks recur throughout the payment plan period, with each payment vulnerable.

Honing in on Gen Z shoppers, there are particular nuances to consider when it comes to BNPL. Many younger consumers use microlending for frequent, smaller-value purchases, and show a readiness to switch between different BNPL providers depending on peer recommendations, promotional offers, and better terms. It's also not uncommon for younger shoppers to combine BNPL with other payment mechanisms, such as gift cards. This multifaceted approach makes it even more challenging for merchants to source enough evidence to refute dubious chargeback claims. With almost two-thirds of Gen Zers saying they’ve regretted financing a purchase with BNPL, and half — yes, half — admitting they would be comfortable committing first-party fraud, this is clearly a massive issue for merchants.

This shouldn’t be the case; in theory, it's typically the lender, not the seller, that bears chargeback liability in a deferred payment purchase. But in practice, this often isn't how things pan out. Some BNPL providers are known to pass chargeback fees and losses to merchants as part of their contracts, and, regardless, a high chargeback ratio can strain the relationship between a merchant and its BNPL provider, as it jeopardizes the BNPL provider’s relationships with its payment processors and the credit card networks. Having a significant chargeback problem can also harm a merchant’s reputation with consumers if this information is conveyed to the general public via third-party review sites or social media.

To fight dubious disputes, compiling robust contextual evidence is crucial — e.g., customer service transcripts, shipping confirmations, tracking numbers, and installment schedules. This typically requires strong cooperation between the merchant and the BNPL provider, since neither party controls all of the relevant data on their own.

Bolstering Fraud Defenses as Digital Wallet Usage Soars

Pay-later plans aren’t the only hot payment trend among Gen Zers. Adoption of digital wallets, such as Apple Pay and Google Pay, is also surging.

Digital wallets appeal to younger consumers (and older shoppers with a tech-savvy outlook) not only because of their one-click convenience, but also thanks to the higher level of security promised through their use of tokenization — a process that replaces sensitive payment data with a unique, random set of characters to better protect information. This focus on enhanced data security is praiseworthy. However, because tokenized transactions provide merchants minimal purchase information or context, they complicate chargeback mitigation efforts. Coupled with the fact that two-thirds of shoppers claim to lose track of how much they spend when using digital wallets, friendly fraud looms large over this new way of paying.

Fortunately, merchants can work with third-party data providers to link the customer details that are available — such as phone numbers — to the holder of the card stored within the digital wallet, giving them additional proof of the transaction’s validity or invalidity.

Catering to Gen Z Demands

The evolving payment preferences of Gen Z present undeniable chargeback challenges for merchants hoping to tap into this massive generational cohort. However, with careful strategy and expert guidance, the risks can be mitigated.

Though digital wallets and BNPL complicate the payment dispute process, their popularity is surging for good reason — convenience, flexibility and security matter to shoppers, young and old. By working closely with payment partners, sellers can cater to these demands while also bolstering their ability to fight illegitimate claims.

The key is ensuring payment processes are properly configured, setting clear policies and having robust mechanisms for compiling contextual evidence. Get these things right as the economic outlook brightens and merchants will be well-positioned to capitalize on Gen Z’s spending power without compromising their chargeback defenses.

Roenen Ben-Ami, co-founder and chief risk officer of Justt.ai, is an expert in the field of payments and chargeback mitigation.