The Real Reason Behind Patreon’s Controversial Fee Structure Change

Patreon’s announcement on their upcoming fee changes has caused a mini-firestorm among creators and patrons alike. While many are accusing Patreon of greed or bias against small donors, the real reason for this change is more likely something much less newsworthy —friendly fraud.

What is “friendly fraud”? By definition, it’s a dispute a customer opens with their issuing bank for a transaction made with their own credit card. Sometimes, fraud is committed intentionally by the customer (i.e. the customer purchased the good or service with the intention of disputing the charge). More often than not, friendly fraud is committed unintentionally by a customer who is confused by a charge on their credit card statement.

Why do I think this is the real underlying reason for the change? Without directly mentioning the word “fraud”, their announcement not-so-subtly points to major patron confusion around the timing and the batched amount of charges:

…we receive literally thousands of support tickets (complaints) about payments confusion every single month.
We want a Patreon where all creators receive their money as soon as a patron pledges. We want a Patreon where your patrons never have to wonder when they’ll be charged, or how much they’ll be charged

In fact, Patreon even published a blog post back in April alluding to their unsurprising “friendly fraud” problem.

These disputes, otherwise known as chargebacks, are notoriously expensive, both financially and operationally, for merchants to manage. For marketplaces like Patreon, the financial losses from chargebacks are actually magnified if Patreon takes on fraud liability on behalf of creators (which I believe it does).

Let’s take a simple example to understand why friendly fraud is so damaging to a platform like Patreon. Assume a patron Alice, under the current fee structure, made 20 $1 donations to 20 creators last month and was charged $20 at the beginning of this month. Alice reviews her monthly credit card statement generated in the middle of this month and sees a single charge for $20 from Patreon, which she is confused by (What is this? I never made a donation for $20?!). Alice decides to call her bank and open a dispute, claiming that she never made this purchase.

At this point, Alice’s bank contacts the card network associated with Alice’s credit card (i.e. Visa/MasterCard/American Express), which in turn contacts Patreon’s payment processor (i.e. Stripe). Finally, Stripe alerts Patreon that the customer has claimed this transaction to be fraudulent and kicks off the dispute process.

As soon as Stripe recognizes a transaction is being disputed by a customer’s bank, it will instantly deduct a $15 dispute fee from Patreon’s Stripe balance and immediately reverse the disputed charge regardless of the eventual outcome of the dispute (Ouch). Given Patreon assumes fraud risk on behalf of creators, then contractually it must still payout the original $20 donation to the 20 creators despite the pending dispute (Ouch ouch).

So what’s the damage? With one $20 dispute, Patreon has now lost:

  • The Stripe dispute fee of $15
  • The net payout to creators of $20 * (100% - (5% + ~4%))
  • The original Stripe transaction fees of $20 * 2.9% + $.30
  • Stripe payout fees (the volume-based fee Stripe charges for payouts) of $20 * .91 * .25%

Total loss = $15 + $18.20 + $0.88 + $.05 = $34.13!

Now let’s assume this was a good transaction that was never disputed. In this situation, Patreon would make:

  • The net fee of $20 * (5% + ~4%) = $1.80
  • Minus Stripe transaction fees of $20 * 2.9% + $.30
  • Minus Stripe payout fees of $20 * .91 * .25%

Total net revenue (What Patreon keeps after payouts) = $1.80 -$0.88 -$.05 = $0.87.

$0.87 is around 4.35% of the original donation amount. For Patreon to break even on a $34.13 loss, it would need process an additional $34.13/.0435 = ~$785 in additional “good” donations to make up for one $20 dispute!

More than just the $34.13 loss, Patreon needs to factor in the operational cost of disputing the chargeback (a highly manual process that involves gathering evidence on why you believe the transaction was valid and submitting the evidence back to Stripe) and the customer support costs resulting from supporting confused patrons and creators (which it alludes to in the blog post as being unusually high). The combined financial losses and operational cost of managing a single friendly fraud case simply becomes unsustainable for a low-margin marketplace that assumes fraud risk on behalf of its recipients.

So how does the new payment fee structure theoretically reduce friendly fraud? Patreon’s payments team is likely betting on a significant reduction in patron confusion, and thus the rate of friendly fraud as a % of total transactions, by charging the patron’s card immediately (i.e. reducing confusion due to transaction timing) and charging the patron’s card per donation (i.e. reducing confusion by linking a single charge with a single donation).

The plan, however, could easily backfire and create more fraud losses than before. Why? What used to be a single $20 charge is now 20 $1 charges. If Alice, for whatever reason, decided to dispute all 20 $1 charges, then Patreon would be out:

  • 20 Stripe fees of $1 * 2.9% + .30 = 20*.329 = $6.58
  • 20 * $15 Stripe dispute fees = $300
  • Net payout to creators of $20 * (100%-5%) = $19
  • Stripe payout fees of $20 * .95 * .25% = $.05

Total loss from 20 $1 disputes = $6.58 + $300 + $19 + $.05 = $325.68 or almost 10x the original scenario!

Why would Alice now dispute these charges? Patreon will likely find that, at least in the short term, friendly fraud will just shift from confusion over the timing and batched payment amount to confusion over the additional fee that patrons did not owe before. If Alice thinks she donated a series of $1 donations but instead sees a long list of $1.38 charges on her credit card statement, she might dispute the charges or call into support.

Moreover, I believe that the new fee structure might open Patreon up to more true or identity fraud in addition to friendly fraud. Why? Unlike before, true fraudsters will now be able to more easily cycle through stolen credit cards by testing a lot of small transactions on various cards and get instant feedback (i.e. an approved or denied signal) since charges will be charged up front versus batched and processed at a later time.

Only by launching the new fee structure will Patreon be able to identify whether this change will actually reduce friendly fraud caused by settlement timing and batched payments. Unfortunately for Patreon, they may find that this change only shifts payment fraud to other channels while angering their creators and patrons in the process.