What Are Chargebacks And Why Should You Avoid Them?

eCommerce companies can lose $31 billion each year due to chargebacks. What started as a legal mechanism to protect shoppers from fraud has become a constant threat to the profitability of online merchants, as well as a hassle for the consumers who should benefit from it.

Let’s have a look at how the chargeback process works and why merchants should always keep the number of chargeback requests opened against them at a minimum.

What is a chargeback?

Let’s start with the chargeback definition:

A chargeback is a transaction in which an issuing bank pulls funds from a merchant and gives them back to a consumer. This usually occurs because the consumer has escalated a dispute about a purchase to their bank for resolution. 

A chargeback is different from a refund. Instead of contacting the merchant from which the purchase was made and requesting a refund, a shopper can go directly to their bank and request that the funds be removed from the merchant’s account.  

The chargeback process was designed to protect shoppers from fraud or unscrupulous merchants. Credit or debit card crime is still rampant today – thieves or cybercriminals may obtain and use a person’s card details to make all sorts of payments,  the cardholder unaware until informed by the issuing bank or checking their account. At that stage, the cardholder can ask the issuing bank for a chargeback. The bank will investigate the transaction in question and, if fraud is suspected, will forcibly remove the funds from the merchants’ account and return them to the cardholder’s account.

Chargebacks are also meant to deter merchants from engaging in unethical or fraudulent practices. These might include delivering products that don’t match the advertised specifications or are defective, accepting payments but not fulfilling the orders, or adding hidden extra charges to the shopper’s card. Since dissatisfied customers have the possibility to request their money back by sidestepping the seller altogether, eCommerce companies will normally try to provide the best products and services to their clients.

Whenever a chargeback occurs, payment processors and acquiring banks also extract a chargeback fee from the merchant. That can reach up to $30 per chargeback, and up to $500 if the merchant disputes the chargeback and the process reaches the arbitration stage. Should the merchant win the case, the fees will then be levied on the shopper who has initiated the chargeback.

The chargeback process

1. The cardholder disputes a transaction by contacting the card-issuing bank and requesting a refund (providing a reason for the request).
2. The card issuer reviews the eligibility of the transaction for chargeback. If the request is considered legitimate, the card issuer charges back the transaction to the merchant’s acquiring bank via the relevant card association (Visa/MasterCard/etc.).
3. The card network (association) electronically screens the chargeback for technical criteria compliance and, if confirmed, forwards the chargeback to the merchant’s acquiring bank.
4. The acquiring bank may transfer the money straight away from the merchant’s account to the cardholder, or forward the request to the merchant first.
5. The merchant receives the chargeback notification and, if certain conditions are met, can represent (i.e. oppose) the chargeback to its acquiring bank, providing documentation to show that the transaction was legitimate and should stand. If the necessary criteria are not met, the merchant will have to accept the chargeback.
6. The acquirer forwards the merchant’s representment to the card association.
7. The card network forwards the represented item to the card issuer.
8. The card issuing bank analyzes the case again and, if the merchant’s case is compelling, charges the cardholder’s account again for the disputed transaction.
   However, if the issuing bank considers that the chargeback issue has been inappropriately addressed by the merchant’s representation, it may submit the dispute to the card association. This triggers arbitration by the card association.
9. In arbitration, the card network decides which party is responsible for the disputed transaction. In most cases, the card network’s decision is final and must be accepted by both the card issuer and the acquirer. During arbitration, the card network reviews all information and documentation submitted by both parties to determine who has final liability for the transaction.
10. Arbitration will lead to either the cardholder being charged again for the transaction and for the chargeback fee as well, or the merchant giving the money back to the cardholder and paying the chargeback fee. Should the merchant wish to fight the arbitration decision as well, there is an additional fee of approximately $500, although very few transactions would justify the cost of such an action.

What are the most frequent causes of chargeback requests?

Card Not Present (CNP) fraud is the biggest source of chargebacks according to 48% of merchants, followed by friendly fraud (28%) and then account takeover fraud (7%). However, the same study revealed that 12% of merchants don’t know why they are confronted by chargeback requests, which is rather worrying.

The two most common chargeback reasons we at 2Checkout have observed are fraud and order not recognized. The latter occurs when the shopper doesn’t recall placing a new order or doesn’t recognize a transaction that is listed on their bank statement. It is often related to subscriptions with recurring billing. Most customers don’t know they agreed to be automatically billed for a product or service, often because they just checked a box in the shopping cart without really reading it, or because the box was pre-checked and they didn’t realize what it meant. Therefore, they will dispute the charge.

Fraud is harder to detect and fight, as it can take many complex forms. Card Not Present (CNP) payment fraud has exploded in recent years, mainly due to the growth of eCommerce, mobile payments, and data breaches that have exposed shoppers’ data to fraudsters. However, clean fraud (when a criminal uses someone else’s data to pay), account takeover, or identity fraud together account for only 30% of online merchants’ fraud losses.

Chargeback fraud and friendly fraud are responsible for the remaining 70% of fraud losses. Friendly fraud happens when a family member buys something using the shopper’s payment card without them being aware of it. Therefore, when the card holder sees the unknown order on their card statement, they open a chargeback request. Chargeback fraud, on the other hand, involves a shopper intentionally misusing their chargeback rights to both retain a purchased item and get their money back for it as well. The increased consumer awareness of their chargeback rights and ease of disputing a charge, coupled with the difficulty merchants have in fighting chargebacks, has led to an escalation in chargeback fraud in recent years. Understandably, this has a considerable negative impact on the merchants’ bottom line and the eCommerce climate overall.

The impact of chargebacks

Credit card chargeback requests produce cascading effects that extend beyond the refund costs themselves. Every time a shopper files a chargeback request, the merchant is required to pay a chargeback fee, regardless of whether the chargeback process is eventually finalized or not.

In addition, even if merchants dispute chargebacks and win the disputes, their chargeback rate is not improved. The chargeback rate is a metric that shows the ratio between the total number of transactions and the total number of chargebacks a merchant has earned. The rate is calculated by dividing the number of open chargebacks (regardless of current status) by the number of finalized transactions in the previous month. It should include only finalized transactions for payment methods that allow chargebacks (including credit cards and PayPal).

The average eCommerce chargeback rate for merchants using the 2Checkout digital commerce platform is between 0.3% and 0.4%. Why is that important? A healthy chargeback rate has to be below 1%. Rates exceeding this number iare considered unacceptable by most payment processors, leading to merchant account termination.

Unfortunately, nowadays most merchants do not achieve their chargeback rate targets, which costs them a great deal. For example, last year almost 70% of companies aimed for an optimum chargeback rate below 0.5%, but only about 46% of them achieved that. The more ambitious companies targeted rates of less than 0.1%, but only 18% managed to reach those goals.

Every chargeback request, legitimate or not, brings merchants one step closer to being fined or even losing their merchant accounts with the acquiring banks. Depending on the card association’s rules, fines imposed on merchants for going over certain chargeback rate thresholds can extend up to $10,000 or more. Continued overstepping of chargeback rate limits will then lead to merchant account termination and possibly inclusion on MasterCard’s MATCH list, which will forbid the business from obtaining another regular merchant account with acquiring banks for five years. Businesses that find themselves in such a situation often have no recourse but to apply for high risk merchant accounts, which usually come with steep costs that further erode the merchant’s profitability.

The negative impact of chargebacks is compounded by the fact that only 18% of the merchants who fight chargebacks actually win most of those disputes. What’s more, 11% of online sellers do not even attempt to represent chargebacks, believing that the cost/benefit ratio of such an effort is not in their favor.

Nevertheless, merchants can – and should – do what they can to prevent chargebacks from being levied against them. Doing so will not only help them avoid significant profit losses, but also contribute to the health of global commerce overall.

So how do you prevent chargebacks in 2019? It all comes down to providing a great customer experience, with effective and timely communication towards the shopper, transparency, responsiveness in customer service, and features and policies that encourage customer retention and discourage fraud.

To find out more about chargebacks and learn the most effective tactics and strategies to prevent them (and thus reduce your chargeback rate), download our free ebook on Understanding Chargebacks, here.