Here’s a (not so) fun fact: online merchants suffered more than $20 billion in losses last year as a direct result of chargebacks. But what if I told you that most of those losses were unnecessary and avoidable?
In this post, we’ll explore how this once-obscure payments industry rule ended up costing retailers so much, and how you can protect your bottom line against preventable losses.
What is a chargeback?
In their simplest form, chargebacks are a kind of forced payment reversal. If a cardholder is the victim of fraud or deceptive merchant practices, that individual can simply contact the card-issuing bank and request a chargeback to overturn the transaction.
Chargebacks are described as a litigation-based process. A chargeback plays out like a court case, with the plaintiff (the cardholder) making a claim, and the defendant (you) trying to refute the claim. For example, assume a cardholder finds a transaction on her billing statement she doesn’t recognize. The process works as follows:
- The cardholder contacts her issuing bank to dispute the transaction.
- Issuer assigns a reason code, identifying the customer’s claim.
- The issuer investigates the case, identifies fraudulent activity, and files a chargeback.
- Issuer forcibly withdraws funds from the merchant’s acquiring bank.
- Acquirer reviews the case and passes it along to the merchant.
- Merchant either accepts the chargeback or produces evidence to contradict the claim.
- Acquirer submits representment to the issuer on the merchant’s behalf.
- Issuer reviews representment, and either accepts or rejects the claim.
The process repeats in the event the issuer refuses your claim and upholds the chargeback. This time, though, the card network has the final say as to who “wins” the dispute (a process called arbitration). The arbitration stage is very time-consuming and can cost hundreds or even thousands of dollars, regardless of the original transaction total.
What is the purpose of a chargeback?
Chargebacks were introduced back in the 1970s to build consumer confidence in payment cards, which were still a new and novel idea at the time. In their original context, chargebacks served several important functions:
- Provide recourse in case of fraud: With so much data floating around the digital space, fraud is more a threat than ever. Chargebacks help consumers who become victims of fraud recover their funds.
- Make consumers feel secure: Consumers can use payment cards confidently, knowing they have options in the event of fraud or abuse.
- Deter bad actors: The prospect of a chargeback deters those who might be tempted to sell subpar products or to engage in merchant fraud.
Chargebacks can provide an “ace in the hole” for buyers. Thus, the power over card payments is ultimately in the consumers’ hands. But, while chargebacks are a valuable and useful consumer protection mechanism, they’re not without problems.
As mentioned above, the chargeback process dates back more than 40 years. We’ve seen incredible shakeups in the marketplace since 1974, including the rise of ecommerce, alternative payments, EMV chip cards, and more. However, the way we administer chargebacks remains more-or-less the same.
The chargeback process is not responsive to a dynamic, digital global market… and that’s a big problem.
Why chargebacks are a pain for merchants
Over the last decade, chargebacks evolved from an obscure payments industry practice to a major ecommerce pain point.
Chargebacks entail lots of additional liabilities and drain on your bottom line:
From the consumer’s perspective, a chargeback is basically the same thing as a return. However, chargebacks and merchant returns are actually very different. Sure, in both cases you lose sales revenue generated by the original transaction, but, unlike a standard return, you’re unlikely to recover merchandise after a chargeback.
Extra chargeback fees
Your acquirer charges a fee to cover chargeback administration (typically between $20-100 per dispute). Even if you win the chargeback dispute, your bank doesn’t have to refund these fees.
Managing disputes, rebuttal letters, and compiling evidence takes time and staff away from other activities.
Disputes can take weeks or even months to resolve. During that time, the funds in question are stuck in limbo.
Consequences of multiple chargebacks
Of course, chargebacks aren’t atomized. An ongoing chargeback problem can lead to some very serious, or even disastrous, consequences:
If your monthly chargebacks exceed predetermined thresholds, you may be designated a “high-risk” merchant. You could be forced to maintain a rolling account reserve, and pay for expensive, regular account reviews.
If chargebacks are a consistent problem, your bank may freeze, or even terminate your account. At this point, you are unable to accept any payments, doing incredible and possibly irreversible damage to your business.
If your account is terminated due to chargebacks, your bank will place you on the MATCH list. You could be blacklisted from getting another merchant account, making it impossible to accept card payments for up to five years.
Inconsistent chargeback rules
Each card scheme has its own unique rules governing chargebacks. For example, Visa implemented the Visa Claims Resolution initiative back in 2018, as an attempt to modernize and speed up their chargeback procedure. Mastercard is in the process of rolling out a similar initiative right now.
While these updates represent progress, the fact remains that banks are the ones adjudicating disputes. They need to interpret the card scheme rules, adding a level of subjectivity to the equation.
The discrepancies and lack of standardization in chargeback processes led to the rise of a major payments industry problem over the last decade, commonly known as “friendly fraud.”
What is friendly fraud?
Friendly fraud describes a situation in which a cardholder files a chargeback without proper justification. The cardholder abuses the chargeback process to essentially undo a transaction and recover their money.
We should distinguish friendly fraud from deliberate “chargeback fraud” (also known as “cyber shoplifting”). With the latter, the cardholder makes a purchase with the premeditated intent to file a chargeback and “get something for free.” Friendly fraud, however, tends to be the result of a lack of understanding of the chargeback process.
Common reasons cardholders commit friendly fraud include:
- The customer experiences buyer’s remorse.
- To avoid a restocking fee.
- The return process seems complicated and demanding.
- The customer doesn’t understand the delivery or payment schedule.
- The window of time allowed for a product return expired.
- A family member made the purchase without the cardholder’s knowledge.
- The cardholder authorized a purchase, but can’t recognize it based on the billing descriptor.
Friendly fraud is, for all intents and purposes, an accidental form of fraud — but that doesn’t make it any less damaging.
You’d probably assume most chargebacks result from criminal fraud attacks. In reality, data from Chargebacks911 links fewer than 10% of all chargebacks to criminal tactics like identity spoofing or account takeover.
Friendly fraud causes between 60-80% of all chargebacks. That translates to a projected economic impact of somewhere between $18.6 billion and $24.8 billion in 2017 alone. Those figures don’t even account for related costs like false declines, return fraud, margin compression, and rising long-term costs, all of which could push the dollar figure much, much higher.
Avoid these 5 common chargeback triggers
To proactively avoid chargebacks, you need to understand what causes them. Here are a few common triggers that can make customers more likely to file a chargeback.
1. Confusing policies
If a customer can’t understand your policies, they may see a chargeback as an easier option. Ensure all your policies regarding payment, shipping, billing, and returns are clearly-worded, descriptive, and easy to find on your site.
2. Customer service hassles
Your customer service team is your line of defense against chargebacks. Be sure your customer service information, including a phone number, email address, and social media, is visible on every page.
3. Slow response
When customers don’t get a rapid reply, they’re much more likely to file a chargeback. When immediate live service is unavailable, provide auto-replies to email and social media inquiries, informing customers when to expect an answer.
4. Late shipping
If you provide shipping timetables, be sure they’re accurate. Tracking information and delivery confirmations are also super helpful, giving customers more insight into the shipping process.
5. Over-reliance on automation
Chatbots can help streamline customer service processes, but they’re no substitute for live service. Have a human available to help customers as many hours a day as possible.
5 ways to prevent chargebacks
There’s no way to definitively “prevent” chargebacks. If you conduct business online, there’s always a certain level of risk involved due to the nature of friendly fraud.
Does that mean there’s nothing you can do to stop it? Not necessarily. Here some basic best practices that may help prevent your next dispute.
1. Responsive customer service
It’s best to offer live customer service — via phone, live chat, or both — for as many hours of the day as possible. Make sure your team responds as quickly as possible to all customer inquiries via email and social media. One way to keep up is by outsourcing customer service to a third-party provider like ShipBob partner Simplr.
2. Fast shipping
Thanks to big players like Amazon, contemporary consumers have high expectations regarding shipping. Buyers won’t pay much (if anything at all) for shipping, they expect items to arrive within a few days, and they want the ability to track their orders every step of the way. Partnering with a third-party logistics company like ShipBob can make offering fast, affordable shipping a hassle-free process.
3. Straightforward policies
Ensure your customer service policies and terms of service are simple, straightforward, and detailed. Most of all, make them easy to find from any page on your site and on social media. In your policies, address common concerns like shipping time, and thoroughly explain the conditions under which you accept returns. Note any items that are final sale.
4. Utilize anti-fraud tools
Although criminal fraud represents a minority of chargebacks, it’s still incredibly important to adopt a multilayered fraud strategy. Tools like address verification, geolocation, velocity checks, and customer blacklists are all useful tools. You can also partner with a fraud platform to help coordinate an efficient fraud strategy.
5. Make sure subscriptions are opt-in
Chargebacks are a major issue for merchants using a recurring billing or subscription model. Making all subscriptions an “opt-in” purchase, rather than a negative option, can help. If you employ a negative option billing model, comply with best practices and all card scheme regulations, like Mastercard’s new Stored Payment Credential Mandate.
Partner with a chargeback management service
The above practices can help minimize your risk exposure, but there’s no “silver bullet” capable of eliminating chargebacks. The best option for comprehensive protection is to partner with a chargeback management service.
A good chargeback management service will help you coordinate tools and consolidate your efforts into a unified, comprehensive plan. They use forensic strategies to identify your business’s chargebacks by source, then deploy the right solution to mitigate risk due to criminal fraud or error and handle friendly fraud through tactical representment.
Chargebacks are a complicated and costly issue to manage. But you can protect your business — and your bottom line — with the right tools and support at your disposal.