Chargebacks 101

Chargebacks are one of the biggest challenges merchants face. Merchants lose an average of $3.75 per every $1 to chargebacks, and the average cost of a single chargeback is up to $190. These are not numbers to be taken lightly by any business owner.  

Protecting revenue from the threat of chargebacks is crucial, but first, it’s essential to understand the problem. This guide defines everything about chargebacks, including what chargebacks are, how chargebacks occur, how the chargeback process works, and how merchants can fight chargebacks to recover revenue.  

What are chargebacks?  

A chargeback happens when a customer disputes a charge with their payment card issuing bank, and the bank refunds the transaction to the customer.  

Thoroughly understanding the answer to “what are chargebacks” can help a merchant prepare for these instances. There are various types of chargebacks, but all have negative consequences for merchants by way of fines, fees, penalties, and damage to their business’ reputation.  

What is chargeback fraud?  

There are several reasons cardholders might partake in chargeback fraud. Consumers may not want to go through the return process and deal with fees. Or, they could have buyer’s remorse and miss the return window.  

Chargeback fraud, also known as friendly fraud or “friendly chargebacks,” is a growing problem in the e-commerce industry. Here are some statistics related to friendly fraud:  

  1. According to a report by PYMNTS, friendly fraud accounts for an estimated 60-80% of all chargebacks.  
  1. A study by Kount, a fraud prevention company, found that friendly fraud increased by more than 35% between 2017 and 2018.  
  1. In a survey conducted by the PYMNTS, friendly fraud was identified as the biggest threat to retailers’ profits, with 62% of retailers reporting that friendly fraud has become a significant problem.  
  1. According to a report by Cardrates, friendly fraud costs retailers $10 billion per year in the United States alone.  
  1. Data from Experian shows that friendly fraud has increased by nearly 50% since 2015.    

These statistics highlight the urgent need for merchants to take measures to prevent and manage this type of fraud. By implementing the right tools and strategies, merchants can reduce the risk of friendly fraud and improve their bottom line.  

Chargeback #1: True fraud  

When evaluating the different types of chargebacks, true fraud or unauthorized use is the first term to understand. This happens when bad actors use stolen payment card information to make a purchase, and the true cardholder files a chargeback to dispute the unauthorized charge.  

This type of chargeback typically occurs as the result of identity theft or card skimming. In some cases, unauthorized use could be the result of a family member making a purchase without the actual cardholder’s knowledge. This is a less dishonorable type of chargeback but just as costly for merchants.  

Here are some statistics related to true fraud:  

  1. According to a report by the Federal Trade Commission (FTC), fraud-related losses in the United States totaled $5.8 billion to fraud in 2021, with true fraud accounting for a significant portion of those losses.  
  1. A study by PYMNTS found that true fraud accounts for 20-40% of all chargebacks.  
  1. In a survey conducted by the National Retail Federation, true fraud was identified as the second-biggest threat to retailers’ profits, with 40% of retailers reporting that true fraud has become a significant problem.  
  1. Data from Experian shows that true fraud has increased by nearly 70% since 2015.  
  1. According to a report by Experian, the number of identity theft incidents in the United States increased by 19% in 2019.  

These statistics highlight the need for merchants to implement effective fraud detection strategies to prevent true fraud. By using tools like advanced fraud analytics and machine learning, merchants can identify and prevent true fraud, protecting both their business and their customers.  

Chargeback #2: Friendly fraud  

Friendly fraud happens when a customer seeking a refund chooses to bypass the merchant and go directly to the issuing bank to achieve their desired outcome. This can occur if a merchant has a confusing return policy or if the merchant has no refund policy at all.   

After receiving the product, some customers may claim that they were unaware of the purchase or that they returned the product without receiving credit. This can happen with digital services as well. Regardless of the type of purchase, the customer is seeking to use the product or service without paying for it and is trying to defraud the merchant through dishonest means.  

Friendly fraud can be combated by merchants having clear return and refund policies clearly listed on their websites. Having excellent shipment tracking and delivery confirmation that requires a signature can also help avoid friendly fraud. 

Tip to prevent chargebacks  

Here are some tips we’ve compiled to help manage chargebacks:  

  1. Use proper authorization protocol: When processing card-not-present (CNP) transactions, use AVS and CVV2 to confirm the purchaser’s identity. Protocols like 3D Secure 2.0 can add an extra layer of security to online transactions and cut down on chargebacks.  
  2. Make sure the billing descriptor is clear: Many disputes happen because of confusion or miscommunication. Merchants can eradicate these types of chargebacks by using clear billing descriptors, which include the merchant’s name (DBA) and other details that identify the business. When the customer checks their card statement after making a purchase, there will be less confusion about when or with whom the purchase was made.  
  3. Clearly present policies, terms, and conditions: Having clearly articulated and posted terms and conditions, return policies, and refund policies can help to cut down on chargebacks.  
  4. Optimize customer service: Merchants should have properly staffed customer service phone lines that minimize wait times. Allowing customers to contact by email can be beneficial as well—so long as emails are promptly (within 24 hours) returned. Also, consider implementing chat lines to quickly address customer issues.  
  5. Work with a reputable payment processor: Working with a trusted payment processor that offers consultative services regarding chargeback management can save merchants hundreds of thousands of dollars in the long run. Having a chargeback prevention plan—and a chargeback management strategy—is essential to guarding hard-earned profits against both true and friendly fraud.  

Chargeback vs. refund — What’s the difference?  

With a chargeback, the issuing bank drives the action, while with a refund, the customer deals with the business directly. Refunds and chargebacks are similar in that they both stem from the cardholder and result in the merchant losing money. Chargebacks, on the other hand, are much more costly and can have long-term effects on the business. Both a refund and a chargeback are instigated by a former customer who is unhappy with their purchase and is trying to get their money back.   

When it comes to who handles the money for refunds, the business is in control of the funds up for dispute, and their payment processor must return funds to the customer. Until the payment processor initiates this transfer, no money moves anywhere. For chargebacks, the customer’s bank is in charge and will usually go ahead and pull the funds in question from the business’s account to hold on to while they sort out whether the chargeback request is valid.  

How long do chargebacks and refunds take?  

The process of a refund usually takes three to seven business days, but chargebacks can take anywhere from a few weeks to several months. It can take longer if the business contests the disputed charge.  

How do chargebacks impact the merchant?  

Similar to a refund, when a customer initiates a chargeback, merchants still lose the revenue from the initial sale, as well as the interchange fees, shipping fees, and any other return costs that are sustained.  

Chargebacks, on the other hand, are going to incur a handful of other costs. If a merchant’s account gets terminated due to excessive chargebacks, their business goes on the MATCH list. The MATCH list shows which businesses are blacklisted for having too many chargebacks and makes them unable to secure a new bank account (even with a different service provider) for five years minimum. If they can get a bank account at all, they will be considered a high-risk merchant account which will run them excessive fees and terms, predatory practitioners, and revenue-limiting reserves.  

Debit card chargebacks vs. credit card chargebacks — What’s the difference?  

Although there are many similarities between debit and credit cards, they offer different levels of protection when it comes to chargebacks and fraud. With credit card fraud, the funds technically belong to the bank, not the cardholder, thus, the bank may be more invested in trying to recover the money. With debit cards, the funds belong to the cardholder rather than the bank. Also, in the case of credit card fraud, the cardholder’s liability is limited to no more than $50. For debit card fraud, the cardholder is limited to no more than $500.  

What are the costs of chargebacks for merchants?  

Every time a chargeback gets filed; merchants get hit with a transaction fee. This transaction fee can range from $20 to $100 per transaction, and the merchant must pay this even if they fight it and win. If the customer files a chargeback and keeps the merchandise, the merchant also loses that revenue and any potential revenue from reselling it.  

Extra fines could be levied against the merchant if their monthly chargeback rates exceed the predetermined chargeback threshold. These fines can go up to $10,000, and if chargeback rates continue to exceed the threshold, the bank can terminate the merchant’s account entirely.  

Who is responsible for chargebacks?  

In the process of chargebacks, both merchants and consumers have a role to play. Both sides must understand the protocols, but cardholders need to be aware that chargebacks should only be used in serious cases, such as fraudulent charges. In some instances, both the merchant and the customer may be found liable when a chargeback is disputed. In such cases, the bank may issue a partial chargeback, where only a portion of the transaction is returned to the cardholder.  

Merchants should strive to minimize the risk of chargebacks, and it’s also important for them to challenge invalid chargebacks. By consistently disputing illegitimate chargebacks, banks may be less likely to issue claims against them. Implementing fraud detection strategies can also help merchants identify and prevent fraud before it occurs.  

Let us help you take control of chargebacks  

It’s clear that monitoring and managing chargebacks are critical aspects of running a business. Both merchants and consumers must be informed and vigilant to minimize the risk of chargebacks. It’s vital for merchants to adopt strategies and tools to help them detect and prevent chargebacks. This is where PAYARC can help by providing merchants with the tools and resources they need to effectively monitor and manage chargebacks, ultimately leading to a more secure and successful business.  

If you want to take control of your chargebacks, talk to an expert at PAYARC today!