What is Chargeback
Understanding what is chargeback and how it might negatively impact your business is crucial for all online merchants. We explain this crucial concept for the benefit of all online merchants.
What is chargeback?
What is chargeback and how might it affect your business? A chargeback is a transaction reversal that cardholders initiate when they notice a fraudulent activity on their card activity. Ultimately the aim of a chargeback option is to protect the consumer from fraudulent activity. To ask for a chargeback, the cardholder typically does not contact the merchant but contacts the issuing bank directly which, in turn, refunds the disputed amount to the cardholder.
Chargebacks can be a significant challenge for any merchant in the online commerce space. It’s important for merchants to prevent or reduce chargebacks as a high chargeback rate increases company fees and damages a business’s reputation. For instance, merchants can monitor their customers’ payment behavior to identify any increase in the rate of chargebacks. This might indicate that there is something wrong with a particular product or service. By doing so, merchants are able to take the necessary measures that will prevent chargeback cases from future customers.
Is chargeback the same as a refund?
A chargeback refund is not the same as a standard refund. A chargeback refund affects a merchant to a higher degree than a standard refund, as it results in bank fees and affects the company's sustainability and profitability. From the customer's end, a standard refund request will be submitted directly to the merchant whereas a chargeback request will be submitted to the issuing bank of their credit card.
When do chargebacks occur?
Chargebacks can occur under many different circumstances. The most common reasons a customer asks for a chargeback are:
- Fraudulent transactions – Fraud reason code chargebacks occur in cases where the cardholder is stating that he did not authorize the transaction. For example, when a credit card is stolen and used without the knowledge of the cardholder. Fraudsters use stolen cards to buy products and the legitimate cardholder will file a chargeback when they realize that their card is lost, causing an increase in the merchant’s chargeback rate. Fraud management tools are a must-have for e-commerce merchants to protect them and their clients from fraudulent transactions.
- Service-related – service reason code chargebacks occur when the cardholder is disputing that the service was not provided, or was simply not as advertised. For example, when an item goes missing during delivery and the customer does not receive a product that they have paid for then a chargeback can result. Sometimes consumers pretend that they didn’t receive the product they ordered so they will ask for their money back and keep the product as well. That is why it is essential that merchants should include a tracking number for every shipped product to prevent cases of missing goods.
- Technical issues – this could be, for example, when a customer accidentally clicks submit twice when purchasing a product and therefore is charged twice for a single purchase. Let your customers know that in case such a scenario happens, they should contact you directly to resolve the issue instead of requesting a chargeback.
- Expired account number or credit card – an expired or invalid credit card or account number should be recognised and rejected by the payment gateway to protect the business from chargebacks this undesirable situation.
There are several chargeback reason codes used by the schemes to describe the type of chargeback initiated. Response time limits vary depending on the reason code. For example, a chargeback on a Visa transaction due to merchandise not received has a time limit to respond of 540 days. Whereas, a chargeback one for a recurring transaction continuously charged to the cardholder, despite him giving notice of cancellation, has a 120 days response time limit.
No matter how small or large your business operations are if you accept credit card payments online it is necessary to have a chargeback prevention and management strategy in place. It is absolutely crucial to choose a payment service provider with a payment gateway that is equipped with the latest fraud management features.
The chargeback process involves all the steps from the initial dispute to the resolution of the chargeback issue. The cardholder and the merchant are the obvious parties involved, but the issuing bank, the acquiring bank, and the payment gateway are all part of the chargeback process as well.
The parties involved in a chargeback
As mentioned earlier, this chargeback process involves the following parties:
- The cardholder – the consumer who uses a credit/debit card to purchase goods or services. The cardholder is the one who initiates a chargeback request most of the times.
- Issuing bank – the bank who issued the credit or debit card to the cardholder. During this particular In a chargeback process, the issuing bank performs a review of the request reviews the chargeback and has the final say on whether the case will be in favor of the merchant or if the cardholder will get a refund.
- Credit card company- the major credit card companies are Visa and Mastercard. Different rules and procedures might apply from each credit card organization.
- Merchant – the company from which the consumer purchased the good or service. Merchants must follow certain regulations during the payment process which are set by the credit card companies they support.
- Acquiring bank – the financial institution that handles the payments of the merchant’s account. The acquiring bank is responsible for ensuring that the merchant operates based on the regulations of the credit card organizations. When a chargeback occurs, the acquiring bank is informed by the issuing bank about the issue chargeback and has to decide if they will consent or if they will dispute it. A chargeback dispute will demand the merchant to provide evidence to the issuing bank to support their case.
- Payment gateway – this is where the transaction in dispute was initially processed. An online business must be linked to a payment gateway in order to accept online payments. This is where Powercash21 can help.
Obviously, the entire chargeback process is not a quick and simple procedure that only involves the consumer and the merchant, and it costs time and money, especially for merchants.
Standard refund vs chargeback refund
All merchants who accept credit card payments will deal with refunds; whether those are standard refunds or chargebacks. A standard refund affects a merchant to a lower degree in comparison with chargebacks a chargeback refund. That latter results in bank fees, affects the company’s sustainability and profitability, and a lot more. The two types of refunds can be distinguished as follows:
Standard refund: the customer contacts the merchant directly and asks for a refund. This is what most customers think of when it comes to refunds. It most often occurs when a customer is not satisfied with a product or service, or something they purchased hasn’t arrived on time through an online purchase. This common form of refund is something merchants deal with every day and there are plenty of workarounds that are beneficial for both the merchant and the customer alike.
Chargeback refund: the customer asks the bank who issued their credit card (issuing bank) for their money back, instead of contacting the merchant to resolve the issue.
In the case of the latter, merchants have two options: accept it or fight it. If they decide to fight it the chargeback, they will get in a process called ‘chargeback representment’ where they dispute a chargeback by presenting evidence to support that it the chargeback isn’t justified. In the case of a chargeback, things become a bit more complicated for the merchant since they have to deal with banks instead of directly with the consumers. Strict procedures are in place, and it is more difficult to deal with a chargeback than with a refund.
The chargeback procedure - how to handle chargebacks
The chargeback is either initiated by the cardholder or the issuing bank. If the issuer initiates the chargeback, which usually happens due to an error in a transaction’s processing, then the merchant’s acquiring bank handles the case and submits the necessary documents on the behalf of the merchant.
On the other hand, chargebacks initiated by the cardholder are passed onto the merchant who will decide whether they will accept or fight the dispute the chargeback. If the merchant chooses not to accept the chargeback, then they must submit all required documentation to their acquiring bank, to prove why the cardholder should not receive their money back. After that, the acquiring bank will forward the files to the cardholder’s issuing bank who has the final say on whether the chargeback will stand or not.
More analytically, here are the possible steps during the to a chargeback dispute process:
- Retrieval Request: A retrieval request is usually the first action that will be taken by the issuing bank on behalf of a cardholder. This is a request for comprehensive information on the transaction in question and a merchant would have 30 days to provide this information. This action will usually be followed by a chargeback. If a merchant does not respond to a Retrieval Request within the allotted time, they are no longer permitted to dispute the transaction. A chargeback occurs when the issuing bank and the cardholder both want to dispute the transaction. The issuing bank will then inform the acquiring bank who informs the merchant. Timelines to respond depend on the chargeback reason code.
- 1st Chargeback: This is the first notification that the acquirer receives from the issuer. It will detail all the information relating to regarding the transaction. Merchants have 40 days to reply to this. In those cases where there is no reply to the chargeback disputed transaction, it will be accepted and funds will be sent back to the cardholder (and deducted from the merchant’s settlement).
- Chargeback Representment: The chargeback representment starts when a merchant decides to contest a transaction and provides sufficient proof to contest the dispute. The acquiring bank will send the documents collected from the merchant back to the issuer for representment. At this stage, it is at the discretion of the cardholder and the issuing bank to continue the dispute. They can decide against it based on the evidence or they can continue the dispute which will lead to the 2nd chargeback stage. The cardholder has 45 days to initiate a 2nd chargeback.
- 2nd Chargeback: The cardholder still disputes the transaction after representing it. The merchant now has 2 options. They can either do nothing and accept the 2nd chargeback or continue the dispute further. When the merchant chooses the latter the case will then go to the arbitration stage. The merchant has 25 days to respond during this stage.
- Arbitration: This is the final stage of the chargeback process. When the merchant still believes the transaction was valid after a 2nd chargeback they can supply further documents to the acquiring bank. The case will then go to Arbitration which is effectively a court where Visa or MasterCard are the ultimate decision makers. Their decision is final. Fees will be incurred for this stage
What is the difference between chargeback and dispute?
A chargeback is one of the stages in the dispute process. Firstly, a dispute is filed by the cardholder or the issuing bank and if a resolution is not reached, a chargeback is initiated.
What is chargeback protection?
Chargeback protection refers to practices applied by merchants to protect their business from chargebacks. Those include fraud management tools, use of payment descriptors, and clear statements of the refunds and returns policy.
The best ways to prevent chargebacks
All merchants will be faced with chargebacks and their concern should be how to win a chargeback dispute process. However, it’s best to act proactively and apply specific measures to protect their business and the customer from going through the chargeback procedure. If you take the right steps towards the solution of the problem, the conflict will be much smoother. Being unprepared for chargebacks is half the problem.
Some of the best tips you could follow as a merchant to prevent chargeback issues include:
- Follow protocol – for card-not-present purchases you should take all necessary steps to ensure that you capture important customer verification information such as IP Address and digital signatures. Very importantly, internet purchases should be authenticated through the use of scheme services like Verified by Visa and MasterCard SecureCode, which have the capability of shifting liability for fraudulent transactions to the issuing bank rather than the merchant.
- Ensure you are using recognizable payment descriptors – these descriptors appear on the credit card statement of cardholders describing what the credit card was utilized for. Payment descriptors should be as clear as possible. Descriptors could be the merchant’s name or website and could include the customer service number. An unclear payment description might confuse the customer who might proceed to a chargeback request.
- Deal quickly with customer service issues – most credit card processors provide chargeback notifications so that you can quickly deal with a customer who is disputing a charge. Best practices mean addressing these issues in a prompt manner and reaching out to the customer if they are not satisfied with something to resolve the issue.
- Look out for signs of fraud – using secure payment processor systems can ensure that signs of fraud are quickly identified. Fraud prevention tools are vital for the protection of every business that accepts credit card payments.
- Clearly state your returns and refunds policy on your website – inform your customers about the available ways to return a product and how they can ask for a refund. This ensures that there will be no need for them to contact their issuing bank to request their money back. Some customers might not be sure what is chargeback and might see it as an easy solution, so provide them with the clearest information possible on how they can ask for a refund if they need to.
- Provide employees with training – technology is really helpful for identifying fraudulent transactions but teaching your staff fraud prevention techniques such as manually identifying suspicious activity is equally important.
- Keep solid records – accurate records of card transactions, amounts and authorization details are documents that you can use to potentially fight against a chargeback if you end up disputing the claim.
Use the above strategies to identify which chargeback claims to fight – combating every chargeback transaction dispute could cost you a substantial amount in additional fees. It could also damage your relationship with your acquiring bank. Identify which cases are worth pursuing and which are best not to dispute.
E-commerce transactions are on the rise and merchants should definitely invest in fraud prevention features, the type offered by Powercash21, to protect their business from excessive fees due to chargebacks.
Friendly fraud vs Chargeback fraud
A definition of chargeback fraud – If someone came up and asked “what is chargeback fraud”, how would you define it? Similar to shoplifting that takes place in a physical store - it is when the customer initiates a chargeback process on purpose and asks to get the transaction value back while portraying himself as a victim. This is mostly the case when the cardholder doesn’t want to pay for the product or service they received.
Chargeback: The friendly version
A definition of friendly fraud – a ‘friendly’ fraud is when a customer asks the issuer for their money back instead of trying to obtain a refund from a merchant in the first place, potentially because they are misguided or confused about a purchase they made – for example, they don’t recognize a company name on their credit card statement for an online purchase. If your customer addresses the bank instead of your business then this might have been unintentional. This is one of the biggest reasons customers ask for chargebacks, and it is simply because they did not initially understand what they were supposed to do for a refund or who to get in touch with.
Chargeback fraud and friendly fraud: What’s the difference?
In order to distinguish what is friendly fraud from what is chargeback fraud, you should try to understand the customer’s motives. A friendly fraud involves a cardholder who doesn’t recognize a transaction or is not sure how to ask for a refund.
Chargeback fraud involves a cardholder who intentionally asks for a chargeback refund and wants to keep the product and get the money back as well. This can happen in many cases, but the most common case is that there are no clear instructions on how you should ask for a refund, therefore, the customer ends up asking for a refund from the bank they are associated with. Unknown to the consumer, they could have more benefits if they directly contacted the merchant without creating a chargeback case.
Chargeback’s collateral damage and additional fees
Chargebacks not only affect the reputation of a business and the merchant’s relationship with their acquiring bank but cause financial damage as well. The damage is all on the side of the merchant most of the times, that is why, if someone requests a regular refund it is much better than requesting a chargeback. Merchants are of course ready to cooperate and give out refunds for valid reasons since there are no fees associated (if it is not a chargeback). In some other cases, not only can a merchant avoid extra fees but they can also offer alternatives to a customer such as coupons and bonuses for future purchases.
The most common expenses that result from this type of fraud come with a chargeback are:
- Transaction costs: for every transaction, the payment processor charges the merchant a specific fee. If the transaction leads to a chargeback, that means that the fee paid by the merchant is lost. Therefore, a high number of these disputes lead to greater losses for the merchant.
- Operational fees: every order goes through various operations before it is delivered to a customer. More specifically, the merchant has to pick, pack and ship the product. Additionally, they have to manage the inventory, transportation and much more. All those activities are an investment of time and money, from the merchant and in the case of a chargeback, the resources invested will be considered a financial loss.
- Chargeback fees: merchants are charged with a penalty fee from their acquiring bank for every chargeback based on the transaction value.
How to limit potential ‘friendly fraud’ (not chargeback fraud)
Merchants can eliminate the cases of chargebacks due to friendly fraud by providing a clear product description on their website. This description should explain everything that a customer wants to know before buying the product. By doing so, you eliminate the possibility of the user disputing a transaction because the product didn’t meet his/her expectations. However, if the customer is still unsure about a product or service following their purchase, they should be able to easily and quickly contact you to resolve any issues or misunderstandings.
Another great tip to reduce chargebacks that arise due to missing products is to ensure the use of tracking codes for every product you ship. Also, it is advisable to ask for the customer’s signature upon delivery of the product.
Lastly, a great way to eliminate friendly fraud is to send recurring order reminders. Sometimes customers forget that they subscribed for a specific service or product. Then when they notice a payment that was made automatically for something they didn’t remember purchasing, they will most probably contact their bank and ask for a chargeback. Online merchants can use reminders to ensure that their customers are still interested in purchasing that specific product or services they subscribed for, and therefore help prevent chargeback issues.
Chargebacks and how to deal with them
Chargebacks are never a good thing for the merchant, and sometimes not even for the customer. By the time a customer requests a chargeback from them, then there is a whole procedure behind the customer actually receiving their money. It is better for a business if a customer contacts the business directly and asks for a refund if something seems wrong. That is why your business should consider taking the right steps against any chargebacks.
The steps include providing ways that you could inform your customers that they are able to contact you whenever they need something, especially when it comes to problems with their purchases. Let them know that for whatever the problem they encounter, they have the means to contact you first before contacting their bank.
In the case though, that a customer asks for a chargeback, then you should think about the steps you will have to take next. There is a certain procedure to the whole chargeback situation, and there are steps that you can not stay away from. You as a merchant have to take the appropriate steps for a chargeback, no matter the outcome. There are many ways to legitimize the chargeback, and it is better if you consider putting the procedures in place to avoid the potential ramifications that can result.