Chargebacks are a double-edged sword in the world of payments. Designed to protect consumers, they often create cash flow challenges for businesses. However, understanding the chargeback process can turn a potential pitfall into an opportunity.
In this guide from Payment Nerds, we’ll demystify what are chargebacks, explore why they happen, and share actionable steps to prevent and manage them.
Chargebacks Meaning
At its core, a chargeback occurs when a customer disputes a credit or debit card transaction with their bank, resulting in a reversal of funds. Established under the Fair Credit Billing Act of 1974, chargebacks serve as a safeguard against unauthorized transactions and billing errors[1].
Chargebacks vs. Refunds
Refunds and chargebacks might sound similar, but they’re completely different beasts.
A refund is simple: the merchant resolves the issue directly with the customer. It’s faster, less complicated, and doesn’t involve extra players.
Chargebacks, on the other hand, kick off when a customer goes straight to their bank to dispute a charge. This adds layers of complexity, from issuing banks to payment processors, not to mention pesky chargeback fees.
For merchants, chargebacks don’t just mean lost revenue — they can also hurt your reputation if they pile up.
Chargebacks vs. Transaction Disputes
It’s easy to confuse chargebacks with transaction disputes, but the two aren’t the same.
- Transaction disputes happen directly between the merchant and the customer. Think of it as a quick conversation to clarify a misunderstanding — there are no banks or fees involved.
- Chargebacks, however, are a step up (or down, depending on your perspective). They bring in the issuing bank, the payment processor, and sometimes even the credit card network. This escalation not only costs merchants money but also takes more time and effort to resolve.
Keeping disputes at the transaction level is a win-win. Customers get faster resolutions, and merchants save on fees and headaches.
Friendly Fraud: A Growing Challenge for Merchants
Friendly fraud is anything but friendly — it’s one of the biggest challenges merchants face today. This type of fraud happens when customers dispute legitimate transactions, often claiming fraud or non-delivery, either by mistake or with malicious intent.
Whether it’s buyer’s remorse, confusion over a billing statement, or an attempt to get free products, friendly fraud accounts for a staggering 60-80% of all chargebacks[2]. For merchants, the financial and operational impact can be devastating.
Why Does Friendly Fraud Happen?
Friendly fraud can arise for several reasons:
- Forgetfulness: Customers may not recognize a charge on their credit card statement, especially if the merchant’s business name isn’t clear.
- Misunderstanding: Confusion about return policies, billing practices, or recurring charges can lead to disputes.
- Opportunism: Some customers deliberately game the system, disputing valid transactions to avoid paying for goods or services.
Why Is It So Hard to Fight?
Unlike outright fraud involving stolen credit cards, friendly fraud is trickier to disprove. Customers appear genuine, and their claims often come from personal experiences. As a result, merchants must provide substantial evidence to counter the claim, which can be time-consuming and costly.
The Cost of Friendly Fraud
Friendly fraud doesn’t just mean lost revenue — it also comes with chargeback fees, higher processing rates, and reputational damage. Over time, excessive chargebacks can even lead to account termination by payment processors or credit card networks.
How to Combat Friendly Fraud
Merchants can take proactive steps to reduce the impact of friendly fraud:
- Communicate clearly: Make sure customers understand your return, refund, and billing policies. Display this information prominently on your website and before purchase confirmations.
- Use fraud prevention tools: Leverage technology from your payment processor to flag suspicious activity or recurring patterns of disputes.
- Keep thorough records: Maintain detailed documentation for all transactions, including receipts, emails, and proof of delivery. These records are invaluable when disputing invalid chargebacks.
- Make billing transparent: Ensure your business name is easily recognizable on credit card statements to avoid confusion.
While friendly fraud is frustrating, a proactive approach can significantly reduce its impact. By combining clear communication, robust technology, and meticulous record-keeping, merchants can protect their revenue and minimize disputes.
How Do Chargebacks Work?
The entire chargeback process follows these steps:
- Customer Disputes: A cardholder dispute is initiated with the issuing bank for reasons such as credit card fraud, merchant error, or dissatisfaction with a product or service.
- Temporary Credit Issued: The issuing bank reimburses the customer temporarily and notifies the payment processor.
- Evidence Submission: The merchant is informed and must provide evidence, such as receipts, emails, or tracking information, to dispute the chargeback.
- Evaluation: The credit card network evaluates the submitted evidence to determine the legitimacy of the chargeback.
- Resolution: If the merchant’s evidence is sufficient, the funds are returned to their account. Otherwise, the chargeback is granted to the customer.
Timelines and Deadlines
Chargeback deadlines vary depending on the credit card network and the specific reason code. Merchants typically have 30-45 days to respond[3]. Missing these deadlines results in an automatic loss, underscoring the importance of a well-organized dispute process.
Examples of Chargebacks
To put things into perspective, consider these scenarios:
- A customer disputes a charge for an undelivered product and wins the chargeback due to a lack of proof from the merchant.
- A case of credit card fraud where stolen card details were used for unauthorized purchases.
In both cases, maintaining meticulous records and improving transaction transparency can make all the difference.
Why Do Chargebacks Happen?
Chargebacks can be triggered by a variety of issues, including:
- Unauthorized Transactions: Fraudulent charges made without the customer’s consent.
- Merchant Error: Mistakes such as incorrect billing, shipping the wrong product, or failure to deliver goods as promised.
- Customer Disputes: Dissatisfaction with the quality of goods or services, often stemming from unmet expectations.
- Friendly Fraud: Customers disputing legitimate charges, either innocently (e.g., forgetting the purchase) or maliciously.
The credit card network assigns each chargeback a reason code, which categorizes the dispute. Understanding these chargeback reason codes is vital for identifying patterns and addressing root causes.
How Many Chargebacks Occur Annually?
The rise of eCommerce has led to a surge in credit card transactions and, subsequently, chargebacks. According to industry reports, chargebacks account for billions of dollars in losses each year[4]. These losses aren’t just monetary — they also affect a business’s reputation and eligibility for certain payment processing accounts.
For high-risk businesses, excessive chargebacks can lead to higher processing fees, stricter terms, and even account termination. Managing chargebacks effectively is essential to maintaining favorable terms with your payment processor and acquiring bank.
Industries Most Affected by Chargebacks
Some industries face a higher risk of chargebacks due to the nature of their transactions and customer behaviors. Here are the most affected sectors:
- Adult Industry: Privacy concerns and friendly fraud make chargebacks common. Adult industry businesses need clear billing and fraud prevention measures.
- Continuity and Subscription Services: Recurring charges often lead to disputes from customers who forget or misunderstand terms.
- Digital Downloads: Intangible products like software and eBooks are prone to disputes, especially for claims of non-receipt or dissatisfaction.
- Tech Support: Intangible services and mistrust in the tech support industry lead to frequent disputes.
- Law Firms: Disputes for law firms often arise from unclear billing or unmet expectations.
- Nonprofit Organizations: Forgotten recurring donations or unrecognized charges can lead to disputes.
High-risk industries must adopt clear policies, transparent billing, and fraud prevention to minimize chargebacks. Payment Nerds can help.
The Financial Impact of Chargebacks
Every chargeback request costs more than just the value of the disputed transaction. The true cost includes:
- Chargeback Fees: Ranging from $15 to $100, these fees add up quickly, especially for businesses with high chargeback volumes.
- Lost Revenue: Merchants lose not only the sale value but also any products or services already delivered.
- Increased Processing Costs: A high chargeback rate can result in elevated fees from your credit card company.
- Reputational Damage: Frequent chargebacks can hurt your standing with credit card networks and financial institutions, potentially leading to account suspension.
High-risk merchants often face steeper fees and stricter scrutiny, making it crucial to maintain low chargeback rates.
Preventing Chargebacks
Prevention is the best defense against the chargeback process. Here’s how to protect your business:
- Transparent Policies: Develop clear, easy-to-understand return and refund policies. Display these prominently on your website to ensure customers know their options.
- Clear Communication: Proactively communicate with customers about order statuses, shipping delays, and cancellations. A simple email can prevent frustration from escalating into a dispute.
- Fraud Prevention Tools: Utilize fraud detection tools offered by your payment processor. These tools can flag suspicious transactions before they become chargebacks.
- Recognizable Billing: Ensure your business name appears clearly on credit card statements to avoid confusion and unnecessary cardholder disputes.
- Tracking Information: Provide tracking numbers for all shipped goods. Proof of delivery is critical when disputing chargebacks.
- Employee Training: Train staff to handle transactions securely and provide excellent customer service. Well-trained employees can prevent many disputes from escalating.
Fighting Invalid Chargebacks
When faced with an invalid chargeback request, merchants have the right to challenge it. Here’s how:
- Gather Evidence: Keep detailed records of every transaction, including receipts, customer correspondence, and shipping confirmations.
- Respond Promptly: Submit evidence within the deadline set by the issuing bank. Missing this deadline guarantees a loss, regardless of the claim’s validity.
- Leverage Arbitration: If the evidence is inconclusive, arbitration may be necessary. While this process is more expensive, it can resolve disputes that cannot be settled through standard procedures.
While the process can be lengthy, fighting illegitimate chargebacks helps protect your revenue and reputation.
Chargeback Fees and Their Hidden Costs
The financial toll of chargeback fees extends beyond the immediate costs. In some cases, these fees can be up to 2.5 times the transaction value[5]. For high-risk businesses, the stakes are even higher, with stricter penalties for exceeding acceptable chargeback thresholds.
Key Insights
- Chargeback fees are charged regardless of whether the dispute is resolved in the merchant’s favor.
- Exceeding chargeback limits set by credit card networks can result in account termination or suspension.
Conclusion: Mastering Chargeback Management
Chargebacks are an inevitable part of doing business in today’s payment landscape. By understanding the chargeback process, proactively preventing disputes, and challenging invalid claims, merchants can minimize their financial impact and protect their operations.
If you’re a high-risk business struggling with chargebacks, we’re here to help. Get approved, even as a high-risk business, and take control of your payment ecosystem.
Sources
- https://www.ftc.gov/legal-library/browse/statutes/fair-credit-billing-act
- https://www.investopedia.com/terms/c/chargeback.asp
- https://fingate.stanford.edu/receipts-gifts/resource/credit-and-debit-card-chargeback
- a rel=”nofollow” href=”https://www.expertmarket.com/uk/merchant-accounts/chargeback-fraud-statistics”>https://www.expertmarket.com/uk/merchant-accounts/chargeback-fraud-statistics
- https://www.nerdwallet.com/article/small-business/chargeback