Costly Chargebacks and How to Avoid Them

Costly chargebacks can quickly cut into the profits of any company. Therefore, understanding them and how to prevent them is critical in the modern economy. Fortunately, there are a variety of methods that can mitigate chargebacks despite the unique challenges that come with chargebacks.

What is a Chargeback?

When a credit or debit card purchase is forcibly reversed by the bank that issued the card, a chargeback takes place. The purpose of chargebacks is to protect cardholders from fraud. With this slant towards cardholders, it is very common for merchants to suffer negative consequences from the chargeback process. These costly chargebacks are challenging for businesses and can significantly reduce profits. 

Chargebacks provide cardholders protection from merchant errors and fraud along with criminal fraud. Chargebacks were introduced in the 1970s to increase consumer willingness to use early credit and debit cards. By providing limited liability and methods of dispute card use, chargebacks have come at a cost for merchants

Cardholder Liability

There are some differences between credit cards and debit cards regarding fraud protection. With credit cards, cardholders are only liable for $50, while with debit cards, they are liable for up to $500. This low liability for cardholders has made it appealing for some to abuse the system and use chargebacks to commit fraud. 

Costs for Merchants

Unlike refunds, the customer is not required to return any goods purchased with the card in question. Unfortunately, this means that merchants have to refund the money, lose the revenue from the lost items, and typically face chargeback fees from their bank or payment provider. This all snowballs into costly chargebacks that can eat at a business. 

If a company faces enough chargebacks, it could be reclassified as a high-risk merchant. However, this requires them to pay higher transaction fees and lose even more revenue to the costly chargeback process. Chargeback fees from payment processors can range from $15 to more than $100 and quickly add up the costs of the chargeback process. This year, the average chargeback cost is expected to reach $191. This demonstrates a considerable cost to many merchants.  

The Chargeback Process

Costly chargebacks can be disputed. Payment processors notify merchants that a customer has initiated the process. The merchant can provide documents to contest the chargeback, but if the merchant does not respond the issuing bank will rule in favor of the cardholder. 

If the issuing bank rules in favor of the cardholder, the funds are returned to them. However, if the merchant wins, they keep the funds. Both merchants and cardholders can dispute the final decision of the issuing bank and seek arbitration from the card network involved

Why Do Customers Initiate a Chargeback?

Customers can initiate a chargeback for a variety of reasons. These include their card information being stolen and used for fraudulent purposes and merchants incorrectly charging them for a purchase. Or the customer is not satisfied with the purchase and disputes it.

Customers may not recognize the purchase on their bank statement and dispute it even though they made it. Customers may also want to avoid the return process because it is confusing or the return period has passed. Some will initiate the chargeback process just because they do not want to pay for their purchase. 

Types of Chargebacks Merchants Encounter

There are three general types of chargebacks merchants will encounter. Criminal fraud occurs when a criminal uses a card to make an unauthorized purchase. Friendly fraud occurs when the cardholder intentionally makes the purchase and then files a chargeback. While this is sometimes a mistake, it is usually an intentional effort by cardholders. Finally, an error on the part of the penchant can also result in a costly chargeback occurring

Preventing Costly Chargebacks

Preventing chargebacks can be very difficult as there are many moving parts and players, and purchases can be disputed months after they were made. But there are measures merchants can take to mitigate chargebacks. 

Fraud Detection and Purchase Verification

Having multiple layers of fraud detection is critical for merchants to implement. This allows them to search for unusual activity in purchases and cancel high-risk transactions that result in costly chargebacks. In addition, using identity verification such as PINs and signatures adds another layer of verification that decreases the likelihood of a chargeback being initiated. 

Effective Payment and Delivery System

Merchants must ensure that their system for processing and delivering orders is robust. This reduces the likelihood of error on the merchant's part, and the dispute points that cardholders can leverage when they try to commit friendly fraud. In addition, merchants need to ensure that their POS and payment system are constantly up to date to ensure they have the most recent security measures to prevent costly chargebacks. 

Clear Return Policy

Merchants can reduce chargebacks through friendly fraud by making their return policy clear and easy to use. An easy return process increases the number of customers that use it instead of initiating a chargeback. In addition, refunds are significantly less costly than chargebacks and are preferable for businesses. This is critical as many cardholders file a chargeback to avoid going through a complicated refund process. 

Accurate Shipping and Product Information

Providing clear product and shipping descriptions is essential to merchants. Many chargebacks begin when the customer believes their order is lost or does not match the online description. With a clear description, the customer can be fully informed about what they are ordering and how it will be delivered to them. 

Customer Service

By providing easy access to customer service, merchants can prevent costly chargebacks. If a customer has a concern about a purchase they need to be able to reach the merchant and ask. They likely will not need to enter the chargeback process when they get quality customer service. 

Clear Billing Description

Merchants must ensure that their business name is clear in their billing description. Some can take this a step further: a customer service number or link in their billing description. This allows customers to easily verify purchases in their credit card or bank statements and contact the merchant for any issues

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