What is a chargeback?
A chargeback occurs when a customer requests their issuing bank to reverse a transaction. People request chargebacks for various reasons – some are malicious (like friendly fraud), and some because the item they purchased never arrived.
Due to the ease with which customers can request chargebacks, merchants inevitably face these requests at some point. For this reason, chargebacks cost merchants 0.47% of their total revenue annually.
The purpose of chargebacks for credit cards
Chargebacks exist to protect customers while shopping. They protect customers from criminal fraud. If someone steals their credit card details and uses their bank account to purchase something online, customers can request a chargeback and reclaim the amount paid for an item they did not buy.
Customers are also protected against card cloning. If their credit or debit card is cloned and used to make illegal purchases in stores, customers can request a chargeback from their bank.
Understanding the chargeback process
There is a defined process that the customer, merchant, and bank go through when dealing with a chargeback. Here’s what it looks like:
A purchase is made
To qualify for a chargeback, a purchase must have occurred. This is the first stage in the chargeback process: the customer buys a product from a merchant, either in-store or online. The merchant’s payment processing system collects the money from the customer’s bank account using their credit or debit card information.
The customer requests a chargeback
When a purchase is made, the transaction details appear on their credit card statement. If they do not recognize the transaction or did not receive the item, the customer requests a chargeback.
Most banks allow customers to request chargebacks through their mobile banking app. Customers need to provide details of the transaction they wish to dispute and the total amount. Some banks have a standardized form for requesting chargebacks.
Regardless of the method used to initiate the chargeback, it is advisable for customers to keep records related to the disputed transaction. Banks may require the purchase receipt, a copy of the merchant’s return policy, or any communication they had with the merchant regarding the issue to initiate an investigation.
The issuing bank contacts the merchant’s bank
Once the customer’s bank account submits the chargeback, the issuing bank contacts the merchant’s account to verify the transaction. The issuing bank will present evidence for the chargeback, including the reason the customer is entitled to a chargeback.
The issuing bank makes a decision regarding the validity of the chargeback
The merchant’s bank receives the chargeback request and reviews the evidence. If the claim is valid, the chargeback will be issued. Some cards – including Visa – provide time limits for the merchant’s bank to respond to the evidence submitted for the chargeback. This is usually 30 days from the submission of chargeback evidence.
The issuing bank informs the customer
Regardless of the outcome, the issuing bank informs the customer of its decision regarding the chargeback request. If the chargeback is approved, the issuing bank will reclaim the money from the merchant’s bank and return it to the customer.
If the chargeback is denied, the customer has two options: accept the denial of the chargeback or attempt again with arbitration.
Potential arbitration
If the merchant refuses to accept the chargeback request from the customer’s bank, the customer has the ability to retry the transaction.
This is called pre-arbitration and can occur if the evidence previously submitted was not convincing enough or if there has been an update in the case. The merchant’s bank has another chance to review the customer’s dispute and decide whether to accept or deny the chargeback.
If
No decision has been made, a card association is being called – Visa, MasterCard, or others – to resolve the dispute over the chargeback. Both the merchant’s bank and the issuing bank try to avoid this arbitration process as it is costly and time-consuming.
Ultimately, once the dispute reaches this stage in the chargeback, the card issuer’s decision is about whether the merchant should refund the money.
Reasons for Chargebacks
Chargebacks can occur for a variety of reasons. Here are some of the most common reasons:
Fraud
Fraud is a big deal. It occurs when a charge is made at your store but the person did not actually purchase the product. A point-of-sale (POS) system that accepts secure payment technologies like EMV chip cards can help protect your business from this type of fraud.
But there is also what is called “friendly fraud” – when a customer deliberately steals from the merchant by claiming that a legitimate transaction is fraudulent. The fraudster buys an item from your store and files a fake chargeback claiming they did not receive the product or that it was defective.
This type of chargeback fraud is a major problem. It is estimated that 61% of all chargebacks will be filed due to friendly fraud by 2023. Ninety percent of merchants stated that “cardholder abuse of chargebacks” was one of their top concerns for their businesses.
Customer Dissatisfaction
Sometimes, a customer is simply dissatisfied with their purchase. A chargeback can be initiated if the customer requests a refund from the bank without contacting the merchant first. (Chargebacks can often be avoided if the merchant and customer resolve the issue without involving banks.)
Data indicates that only one in 20 customers will complain directly to the merchant if there is a problem with their purchase. The other 19 are more likely to initiate a chargeback.
To help reduce these cases, ensure that your return policy is clearly stated both in-store and online, and even on receipts. Also, try to keep lines of communication open with your customers so you can work together to resolve product or customer service issues as they arise.
Consequences of Chargebacks
Consequences for Merchants
While it would be great to proactively prevent chargebacks, they are an inherent part of running a business and you will likely have to deal with them at some point. If you are lucky, a chargeback is just an occasional nuisance. On the other hand, excessive chargebacks can penalize you as a merchant and lead to a complicated process involving a lot of paperwork, time, and money.
Chargebacks are intended to help customers protect themselves against unauthorized transactions and create a sense of security, but they can sometimes mean a significant headache, especially for small businesses. If a consumer submits a chargeback and keeps the goods, the merchant not only loses that revenue but also loses potential future earnings from those products.
On average, it costs merchants $25 to handle a chargeback incident – sometimes more than the profit they would have made from the disputed order.
Fines exceeding $10,000 can also be imposed on businesses that exceed certain monthly chargeback rates. If there are too many fines, the merchant may be classified as “high-risk” by credit card companies and could even lose credit card processing privileges or face higher fees and penalties related to chargebacks.
Not
only merchants who accept payment by credit card must adhere to EMV security standards. Merchants are responsible for any fraudulent activities that occur after an EMV card is swiped for the customer (as opposed to processing a chip and PIN transaction).
Consequences for Customers
For consumers, there can be negative consequences beyond losing their money. Those consequences deter people from requesting a chargeback for fraudulent reasons – such as claiming they did not receive the questionable item and obtaining a full refund. After all, a customer who wins a chargeback dispute is nine times more likely to initiate another dispute.
To curb customers’ desire to submit fraudulent requests, the chargeback process takes much longer than the average refund. Often, it is faster and easier for the customer to contact the merchant directly to resolve the issue.
If a customer submits a chargeback and the bank discovers it is a friendly fraud case, it may close that credit account, negatively affecting the customer’s credit record. This has a cascading effect on their ability to make large purchases with other merchants.
Customers are also required to cover chargeback fees if they lose the dispute – another method favored by banks to discourage fraudulent chargebacks.
How to Respond to a Chargeback
You should respond to the chargeback as quickly as possible, as delays on your part can lead to a loss of the chargeback. Research the purchase and contact the customer. Sometimes, all a customer wants is to have their complaint heard by someone, and often the situation can be resolved in your favor.
Ensure you have approval for the correct financial amount of the order, and obtain authorization for each package shipped from the store/warehouse.
If a chargeback has already been submitted, the best course of action is to gather as much information as possible. Write a detailed account of how your product or service was purchased and submit all of it to the acquiring bank – which will have sent you the chargeback notice.
It is important to know the reason for the chargeback so that you can tailor your response correctly. It is exactly what it sounds like – the reason they are disputing the charges, which can range from fraud to non-delivery of services or processing errors – and the reason codes differ for each issue across card networks.
Fraud, or “unauthorized” chargebacks, constitutes 56% of all chargebacks, so providing evidence that the cardholder was aware of and agreed to the disputed transaction is crucial. Any evidence proving that – matched address verification, CVV confirmations, signed receipts, or contracts – is vital to your response.
Also, make sure to include the case number or unique identifier for the chargeback on every page of your response. After submitting your response, it is out of your hands as the acquiring bank reviews the information. It is the cardholder’s bank that makes the final decision on whether to uphold the chargeback, and it will notify the customer of its decision.
Finally, if you realize you’ve made a mistake – perhaps you entered the number incorrectly or wrote it down incorrectly in a phone order – own up to the responsibility and the chargeback. You want to maintain your good standing with the financial institution and your customers.
How to Protect Your Retail Store from Fraudulent Chargebacks
Use Fraud Detection Software
Sometimes, the best way to prevent chargebacks is to restrict the environment in which they are likely to occur. Installing fraud prevention software is the easiest way to avoid transactions that could lead to chargebacks. In fact, research has shown that merchants who receive fraud alerts experienced a 19% drop in chargebacks.
To prevent
Refund requests are explained by customer service representative Ashley Shock, who states that Calista uses a “fraud detection app called NoFraud. It scans and analyzes customer orders shortly after they are placed. If any suspicious activity is detected, the order will be passed to an analyst on their team.”
Shock adds: “That analyst will approve or deny the order. If it fails, the payment will not be captured, and the order will not be processed. If a fraudulent order manages to slip through the cracks and we receive a chargeback, NoFraud will cover the cost of that chargeback. It’s really helpful!”
Keep Accurate Records
Keep accurate records of customer credit card transaction dates, amounts, authorization information, etc., in case you need it to fight a chargeback (also keep all your receipts).
Since chargebacks can occur due to cloned or stolen cards, compare the signature on the receipt to the signature on the back of the credit card to ensure they match. You can also request another form of ID if you suspect a fraudulent transaction.
Clearly Describe Store Policies
Another way to prevent fraudulent chargebacks is to clearly describe your products and service policies—especially if you’re selling online—so that the customer is more likely to take responsibility for unsatisfactory purchases.
Establish a clear return policy. This way, if the consumer is dissatisfied with the purchase, you can avoid the chargeback by processing it as a return instead.
Your contact information should also be clearly displayed on credit card receipts and online, encouraging customers to reach out to you with questions before initiating a chargeback. This saves everyone fees and significantly reduces the time spent evaluating whether to issue a refund.
Chargeback Prevention in Retail
While merchants will never like chargebacks, consumers need this level of protection when purchasing goods from merchants. Chargeback rules encourage fair and honest return policies and discourage the sale of low-quality products.
However, the system is sometimes abused by consumers, and merchants literally pay the price—and then some. Hopefully, the number of fraudulent chargeback claims will decrease in the future as awareness of chargebacks increases, both for merchants and consumers.
Use the tips in this guide to prevent them. But at least, now you know how to handle it if chargeback requests do go beyond the norm.
Handling Chargebacks at the Point of Sale
Merchants who choose Shopify to run their business get integrated payment processing and an automatic dispute resolution solution, which combines in-store and online transactions, receipts, shipping, and package tracking, helping you win more disputes and save more chargeback fees. Start your free trial today.
Chargeback FAQs
How does a chargeback work?
A chargeback is the process of reversing a customer’s credit card payment back to the merchant. This can happen for various reasons, including fraud, incorrect or unauthorized shipments, or unsatisfactory products or services. The cardholder initiates the chargeback process by filing a dispute with their card issuer. The issuer places a temporary hold on the funds and investigates the dispute. If the issuer finds the charge as valid, the funds are returned to the merchant. If not, the issuer will reverse the charge and credit the cardholder’s account. The merchant may have the option to contest the chargeback, although the issuer’s decision is typically final.
Does a chargeback mean a refund?
No,
Chargebacks and refunds are not the same thing. A chargeback is a process initiated by the cardholder or the issuing bank to reverse a credit card transaction to the merchant due to a dispute over the quality or delivery of goods or services. A refund is a process initiated by the merchant to return funds to the cardholder due to an unsatisfactory purchase.
What happens when a customer initiates a chargeback?
When a customer initiates a chargeback, their bank reverses the original transaction and the amount is deducted from the merchant’s account. The merchant then has to dispute the chargeback with the issuing bank and provide documentation explaining why the chargeback is invalid. If the merchant successfully challenges the chargeback, the funds are returned to their account. If the dispute is unsuccessful, the merchant will be liable for the chargeback and any associated fees.
What is an example of a chargeback?
An example of a chargeback is when a credit card holder contacts their bank to contest a charge that was made on their account without their consent. The bank investigates the complaint and if necessary, reverses the charge and refunds the money to the cardholder’s account.
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