What Is a Chargeback: A Primer for Merchants

A chargeback is when a customer makes an online purchase with their credit card and then requests a chargeback from the issuing bank after receiving the purchased product or service. Below is a guide that will share the essential things merchants need to know to understand the different types of chargebacks, their effects, and prevention strategies.

What is a chargeback?

A chargeback is a process that allows credit cardholders to dispute a transaction and secure a refund for their purchase. Originally designed to protect consumers from unauthorized transactions, chargebacks involve the reversal of funds from the merchant’s account to the customer’s account if the dispute is deemed valid.

Because the chargeback process is a legal mechanism designed to protect consumers from unauthorized or fraudulent transactions, it is also complex and challenging for merchants.

Here’s an overview of the typical chargeback process:

1. Dispute Initiation

• Customer Discontent: The chargeback process begins when a customer disputes a transaction. The reasons can vary from unauthorized charges and non-receipt of goods or services to dissatisfaction with the product or service received.
• Bank Notification: The customer contacts their issuing bank to initiate the chargeback dispute. The bank reviews the initial claim to ensure it meets the criteria for a chargeback.

2. Issuing Bank Action

• Chargeback Filing: If the issuing bank deems the dispute valid, it will file a chargeback on behalf of the cardholder. This action temporarily credits the cardholder’s account while the dispute is being resolved.
• Merchant Notification: The merchant is notified of the chargeback and is given details about the case, including the reason for the chargeback and any relevant dispute codes.

3. Merchant Response

• Evidence Submission: The merchant has the opportunity to respond to the chargeback. This involves providing evidence to the acquiring bank (and sometimes directly to the card network) to prove that the transaction was legitimate. Evidence can include receipts, invoices, proof of delivery, communication records, or any other relevant documentation.
• Deadline Awareness: Merchants must respond within a specified timeframe, typically within 7 to 21 days, depending on the card network and the acquiring bank’s policies.

Chargeback representment companies can help merchants at this point to navigate the process and win more chargeback disputes than they would on their own.

4. Acquiring Bank Review

• Evidence Evaluation: The acquiring bank reviews the evidence provided by the merchant. If the evidence is compelling, the bank will represent the transaction to the issuing bank, contesting the chargeback on behalf of the merchant.
• Decision Communication: The acquiring bank communicates the decision to the merchant. If the merchant’s evidence is deemed sufficient, the chargeback may be reversed, and the funds returned to the merchant’s account.

5. Possible Arbitration

• Continued Dispute: If the issuing bank disagrees with the acquiring bank’s decision, the dispute can escalate to arbitration by the card network (e.g., Visa, Mastercard). This is a more formal process where the card network makes a final decision.
• Final Decision: The arbitration decision is final and binding. Additional fees may apply, and the losing party (merchant or issuer) is typically responsible for these costs.

6. Resolution

• Funds Transfer: Depending on the outcome of the dispute and any potential arbitration, funds will be permanently moved either to the cardholder or the merchant.
• Chargeback Record: Regardless of the outcome, the chargeback will be recorded in the merchant’s history, which can impact their chargeback ratio and potentially their relationship with payment processors.

Types of Chargebacks

Impact of a fraudulent chargeback on businesses

What is a small chargeback problem to one merchant might be a large problem to another. But in general, even a small volume of chargebacks can any hurt business in several significant ways, impacting its financial health, operational efficiency, and reputation. Here’s a breakdown of how chargebacks can negatively affect businesses:

1. Financial Loss: When a chargeback occurs, the merchant loses not only the revenue from the sale but also the product or service that was provided. Additionally, businesses incur chargeback fees, which can be substantial depending on the payment processor’s policies.
2. Increased Processing Fees: A high number of chargebacks can result in a merchant being categorized as high-risk, which often leads to increased payment processing fees. In severe cases, a business might even lose its ability to accept credit card payments if the chargeback ratio exceeds the thresholds set by payment processors or acquiring banks.
3. Resource Allocation: Responding to chargebacks requires time and resources. Businesses must compile evidence to dispute chargebacks, which can be a time-consuming process that diverts staff from other productive activities. This operational disruption can affect a business’s overall efficiency and profitability.
4. Inventory Loss: In cases of physical goods, the merchant may not recover the sold product, leading to inventory loss in addition to the revenue loss. This can be particularly damaging for small businesses or those dealing with high-value items.
   
5. Merchant Account Jeopardy: Excessive chargebacks can lead to a merchant’s account being terminated by the payment processor. If a business loses its merchant account, it becomes significantly more challenging to find another processor willing to onboard a high-risk merchant, disrupting the ability to conduct online transactions.
6. Increased Scrutiny and Regulation: Businesses with high chargeback rates may face increased scrutiny and regulatory burdens, including mandatory implementation of fraud prevention tools or stricter compliance requirements, which can further increase operational costs.

What type of businesses are most impacted by a fraudulent chargeback?

What is a chargeback problem for one industry may not exist in another. Chargeback fraud can affect any business that accepts card-not-present (CNP) transactions, but some industries, such as Twitch streamers, espeically are more susceptible due to the nature of their products or services, their transaction volumes, or the typical purchasing behavior of their customers. Here are some types of businesses that are often most impacted by chargeback fraud:

1. E-commerce: Online retailers are particularly vulnerable to chargeback fraud since they deal with CNP transactions. The inability to physically verify the card or cardholder during the transaction increases the risk of fraud.
2. Digital Goods and Services: Businesses that sell software, online media, subscriptions, or any form of digital content often face chargeback fraud because the intangible nature of these products makes it easier for customers to claim they did not receive the goods or were unsatisfied.
3. Travel and Hospitality: Airlines, hotels, and travel agencies experience high levels of chargebacks due to the high cost of transactions and the fact that services are usually booked well in advance, increasing the likelihood of cancellations and disputes.
4. High-Value Items: Retailers selling jewelry, electronics, or any high-value items are targets for chargeback fraud, as fraudsters may attempt to obtain expensive products without paying for them.
5. Subscription-Based Services: Businesses with recurring billing models, like membership sites, software as a service (SaaS) providers, or fitness clubs, can face chargebacks when customers forget about recurring charges or decide they no longer want the service and choose to dispute the charge rather than canceling the subscription properly.
6. Entertainment and Events: Companies selling tickets for concerts, sports events, or other entertainment can be hit hard by chargebacks, especially if the event is canceled or if buyers regret their purchases as the event date approaches.
7. Adult Entertainment: Due to the sensitive nature of the products and services offered, businesses in the adult entertainment industry face high levels of chargeback fraud, often driven by buyer’s remorse or the desire to hide the transaction from spouses or partners.
8. Gaming and Gambling: Online casinos and gaming platforms are prone to chargeback fraud, with customers disputing transactions due to non-winning bets or claiming unauthorized card use.
9. High-Risk Merchants: Beyond specific industries, any business classified as high-risk due to its chargeback history, industry reputation, or business model will face heightened impact from chargeback fraud.

Businesses in these categories often require more stringent fraud prevention measures and proactive chargeback management strategies to protect their revenues and maintain good standing with payment processors and banks.

Preventing chargeback fraud

What is a chargeback prevention strategy that merchants can rely on? Preventing chargeback fraud is crucial for maintaining a healthy business. Here are some effective tips for minimizing the risk of chargeback fraud:

1. Clear Communication

• Product Descriptions: Ensure your product or service descriptions are clear, accurate, and detailed to prevent misunderstandings.
• Terms and Conditions: Display your terms, conditions, and return policy prominently on your website and at checkout.
• Contact Information: Provide easily accessible contact information so customers can reach out with concerns before initiating a chargeback.

All of these things can be accomplished by making sure to write a strong chargeback policy that you communicate to customers.

2. Transparent Billing

• Recognizable Billing Descriptor: Use a clear and recognizable name on billing statements to avoid confusion.
• Detailed Invoices: Provide detailed invoices that include itemized purchases, transaction dates, and your contact information.

3. Prompt and Efficient Customer Service

• Quick Response: Respond to customer inquiries and complaints swiftly to address issues before they escalate to chargebacks.
• Resolution Options: Offer refunds or store credits as alternatives to chargebacks when disputes arise.

4. Secure Transactions

• Authentication Measures: Implement fraud prevention tools like CVV verification, AVS (Address Verification Service), and 3D Secure to authenticate transactions.
• Regular Monitoring: Monitor transactions for suspicious activity and flag or decline high-risk transactions.

5. Delivery and Fulfillment

• Proof of Delivery: Use shipping services that provide tracking numbers and require signatures for high-value items.
• Digital Confirmation: For digital goods or services, provide immediate confirmation of the purchase and access or delivery details.

6. Detailed Record-Keeping

• Maintain Documentation: Keep comprehensive records of transactions, customer communications, and delivery confirmations to dispute unjustified chargebacks effectively.
• Analyze Patterns: Regularly review chargeback incidents to identify patterns or common issues, allowing you to address systemic problems.

7. Educate Customers and Staff

• Customer Guidance: Educate customers on how to use your products or services to reduce the likelihood of dissatisfaction.
• Staff Training: Train your staff on best practices for preventing fraud and handling customer disputes effectively.

8. Use Fraud Management Tools

• Invest in Technology: Utilize advanced fraud detection and prevention tools that can analyze transaction data in real-time to identify and prevent fraudulent activities.
• Customize the Strategy: Tailor fraud detection tools to match your business model and risk tolerance, adjusting filters and rules as necessary.

By implementing these strategies, businesses can significantly reduce the risk of chargeback fraud, protect their revenue, and maintain a positive reputation with customers and payment processors.

Merchants will never be able to prevent all chargebacks. However, what is a chargeback problem today can be mitigated through the chargeback representment process, which allows merchants to fight to have chargebacks that were already assessed overturned. This second line of defense is complex, but not impossible if you partner with a sepcialized service.