Credit Card Chargebacks Explained: What Merchants Need to Know

As consumers, most of us have looked at last month’s credit card statement and experienced the panic of not recognizing a charge. Most of the time, customers can identify what the charge is or where it came from by doing a bit of research. If not, filing a chargeback is the next best option.

But credit card chargebacks also occur for a variety of other reasons — and they’re not always honest. This puts merchants in a tough position. If chargebacks start mounting up, this is bad news for your business.

This is why it’s vital to have a good understanding of:

  • Why chargebacks happen
  • Why they’re becoming more common
  • Steps you can take to reduce chargebacks
  • What to do when you receive a chargeback

Luckily for you, that’s exactly what this guide is for.

What are credit card chargebacks?

Credit or debit card chargebacks are when a disputed charge made to a merchant’s account is refunded to the customer’s bank account. Chargebacks are often described as a forced refund, as retailers cannot contest a chargeback until after it’s taken place.

This can be done both for credit card transactions made on an eCommerce website or at a physical store. Chargebacks can occur for a variety of reasons, including:

  • Billing errors (e.g. when someone has canceled a subscription and still receives a charge)
  • Goods or services not being received after the purchase
  • Being charged an incorrect amount
  • Unauthorized credit card usage (i.e. fraudulent charges)

The main purpose of chargebacks is to protect consumers from shady vendors or fraudulent activity. According to the federal Fair Credit Billing Act, consumers can dispute a charge in the case of billing errors and the failure of a business to render goods or services as described.

However, chargebacks have emerged in recent years as the first course of action for consumers who want a refund as quickly as possible — and as a tool for fraudsters looking to take advantage of CNP (Card Not Present) transactions.

This has been aided by the rise of online banking, which has made the chargeback process as easy as a few clicks. It’s possible for cardholders to get a chargeback approved from either their bank or the credit card processing company (e.g. Visa or Mastercard) without having to come face to face with the merchant.

However, a high number of chargebacks has significant implications for businesses. As well as chargeback fees, there’s also the risk of banks choosing to freeze or even terminate merchant accounts.

Fast facts about chargebacks

Credit card chargebacks are not a new issue for businesses. However, they’re fast becoming a much bigger problem for merchants. Current data suggests that global chargeback requests may cost retailers as much as $117.47 billion by 2023, an uptick that can be partly explained by the global boost in online sales caused by the COVID-19 pandemic.

Widespread supply chain disruption during 2020 is thought to have made a significant contribution to chargebacks, with strained parcel networks resulting in bottlenecks during the shipping process. Merchants cite the following reasons for why chargebacks have increased:

  • Delivery delays (45%)
  • Customer service delays (43%)
  • Worker shortage (41%)

According to the Chargeback Field Report, nearly 70% of merchants reported an increase in chargeback rates as a result of COVID-19. Around 47% estimate their company’s current chargeback ratio is between 0.6%-1%, while 33% estimate that it exceeds 1% — a rate that can result in penalties from credit card companies.

The difference between chargebacks and fraud

Chargebacks and eCommerce fraud are often talked about in the same breath, but not all chargebacks occur for fraudulent reasons. Chargebacks are an important consumer protection mechanism to ensure that consumers don’t fall victim to unscrupulous sellers or scams.

So-called “friendly fraud” is a specific form of credit card fraud where a consumer intentionally makes use of chargebacks to obtain a refund without having to pay restocking fees or return shipping. It’s also a way to get around restrictive return policies that don’t allow for buyer’s remorse. It’s estimated that 61% of chargebacks issued in North America by 2023 will be due to incidences of friendly fraud.

How much are chargeback fees?

Chargeback fees are non-refundable fees levied by banks for each credit card payment that results in a chargeback. The purpose of chargeback fees is to cover administrative costs accrued by the acquiring bank.

The size of chargeback fees can vary significantly depending on the type of good/service being disputed and whether the merchant has a prior history of chargebacks. Most chargeback fees vary from $20-$100. However, it’s important to acknowledge that the real costs of chargebacks aren’t just monetary, especially for small businesses.

Dealing with chargeback fees isn’t as simple as just paying the amount due and moving on. The more chargebacks you receive, the higher your chargeback ratio becomes — i.e. your risk factor in the eyes of banks and credit card issuers. A high chargeback ratio can mean additional fees, or even a monthly penalty until your ratio drops.

Chargebacks can also cost businesses in other ways, including:

  • Transaction fees charged by the payment processing company (usually 3-4% of the transaction value).
  • Damage to your credit score.
  • Opportunity costs (i.e. lost sales and customer relationships).
  • Fulfillment and logistics costs (i.e. packing, shipping, and storage).

When adding up these costs, it’s clear that chargeback fees and their associated costs are extremely harmful to your bottom line. So, what can merchants do to prevent chargebacks from mounting up?

Preventative steps to combat chargebacks

Ensure that you’re following the protocols of your payment processor

Payment processors have rules for handling orders placed online, which are known as “Card Not Present” interactions. These involve the highest risk of fraud, which is why extra information such as CVV card numbers or AVS (Address Verification System) is often required. For in-store payments, check that your credit card machine has an EMV reader. This helps you to weed out fraudulent interactions before they happen and cause chargebacks.

Work with a processor that offers chargeback protection

Some payment processing platforms (including Stax) offer features that help businesses avoid chargebacks. Ensure that you’re working with a processor that provides secure payment systems (SPS) that can encrypt and tokenize cardholder information to prevent fraudulent transactions.

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This adds another layer of security (particularly for online transactions) so you can avoid incidents that lead to chargebacks.

Maintain clear, consistent communication

Many customers pursue chargebacks because the business is either difficult to contact or doesn’t respond to their concerns in a timely manner. By putting your best foot forward during the shopping journey with responsive communications, you can establish a trusting relationship where customers feel comfortable reaching out to you. This also means ensuring that your return and cancellation policy is clear to avoid any confusion. You should provide multiple contact options (e.g. email, live chat, and social media) to make it easy and convenient for customers to touch base.

Ensure that customers receive their goods as promised

Ecommerce is made up of a lot of moving parts, and it’s easy for standards to slip when order volumes are high. But poor product descriptions or delayed shipping can result in customers becoming frustrated and pursuing chargebacks, especially if they don’t receive an apology from the merchant. It’s your job to effectively manage expectations and ensure that customers get what they paid for.

Provide payment options that suit your customer’s needs

Traditional card networks such as American Express and Discover are no longer the only options for merchants accepting payments online. As eCommerce has grown, the number of payment options has proliferated. The growing popularity of Buy Now, Pay Later and digital wallets are great alternatives that provide more flexibility.

What merchants should do when they’re hit with a chargeback

Here is a quick summary of the standard chargeback process:

  • The customer decides to file a chargeback with the issuing bank.
  • The issuing bank forwards the chargeback request to the merchant’s bank, aka the acquiring bank.
  • The acquiring bank activates the chargeback, and the customer receives temporary credit pending the merchant’s response.
  • The merchant chooses to either accept or dispute the chargeback.

So, what should you do next?

Understand why the chargeback took place

Knowing why a chargeback happened will help you to determine whether it’s worth disputing. When a customer files a chargeback, a reason code will be supplied that explains the cause.
These come in the form of two, three, and four-digit numbers. Every credit card company has its own unique set of reason codes, which can get confusing for merchants. However, it’s important to have this documentation on hand so you can look up the cause of a chargeback and plan your next steps. For example, if the chargeback is due to an incorrect credit card charge, there’s little point in disputing this. But if a customer is claiming with their goods weren’t received while your shipping tracker says otherwise, it’s definitely worth it.

Note: Different reason codes often stipulate different time limits by which the merchant has to respond, so pay close attention to avoid missing out on a chance to dispute the chargeback.

Prepare your documentation

The biggest downside of chargebacks is that merchants are usually considered guilty until proven innocent. This means that the burden is on you to prove that a chargeback is fraudulent. To use our previous example, tracking information from your parcel carrier in addition to the initial delivery confirmation email will help to establish that the delivery did take place.

Ask your credit card company/bank for advice

Acquirers and credit card processors have a lot of experience dealing with chargebacks, so it’s a good idea to approach them before officially filing for dispute and evidence. This is especially important in the case that the issuing bank files a second charge or asks for arbitration. Remember: They have a vested interest in keeping chargeback rates low, so they’ll be happy to assist.

Take stock of the situation. Whether the issuing bank’s decision is in your favor or not, it’s a good idea to re-examine the process and whether you could have done anything differently. If the chargeback was your fault, consider what mitigating strategies you can put in place to prevent that scenario from happening again.

Final words

Chargebacks are a major hassle for merchants both large and small, so it’s well worth dedicating time and resources to preventing chargebacks and refining your response to them. Even basic measures such as continually touching base with your customer during the post-purchase phase can make a huge difference to the likelihood of chargebacks taking place.

It’s also worth partnering with a payment processor that helps you minimize chargebacks. At Stax, we have payments security built into our platform to help prevent fraudulent transactions and chargebacks from taking place. Stax also provides tools that allow you to mitigate the risks and challenges that come with chargeback practices.

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