Welcome to Chargebacks 101! We look at what merchants & consumers need to know about what chargebacks are, how they work, and when to use one.
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Payment disputes are an inevitable consequence of a digital economy. As in-person, manual transactions are replaced by frictionless, card-not-present payments, the need to fairly arbitrate disputes between merchants and consumers is more important than ever.
Chargebacks are the primary tool banks use to resolve credit card payment disputes. When a consumer did not authorize a charge, or is unhappy with a product or service, they can challenge the charge with their issuing bank. If the bank feels the consumer’s claim is valid, they will initiate a chargeback in order to reverse the payment.
The chargeback process is antiquated and governed by rules that are often unevenly enforced. Both merchants and consumers can feel frustrated by the system.
In this article, we’ll explore how chargebacks work, where they came from, and how they have changed over time. We’ll also examine some of the consequences of chargeback misuse.
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A chargeback is a credit or debit card charge that is forcibly reversed by an issuing bank. This typically happens after a cardholder claims a transaction was the result of fraud or abuse.
Even the most reputable online businesses will struggle with chargebacks. For cardholders, chargebacks act as a shield against criminals or dishonest business practices. For merchants, however, chargebacks can pose a serious threat to revenue and business sustainability.
One study showed that payment disputes resulting from criminal activity cost merchants an estimated $20 billion in 2021. That’s an 18% increase over 2020.
Chargebacks can seem unfair to merchants. They are meant to act as a consumer safeguard. The process is naturally skewed towards the cardholder, providing protection from:
In addition to customer disputes, there is also something called a bank chargeback. This occurs when the issuer detects some anomaly in the transaction process. True to their name, bank chargebacks are resolved between the issuer and acquirer.
To cardholders, chargebacks can seem just like traditional refunds. They’re not, though. That’s the problem.
With most refunds, the cardholder is obligated to return whatever was purchased to get their money back. That’s not the case with chargebacks, where the cardholder bypasses the merchant altogether and asks the bank to intervene.
When this happens, the merchant loses the revenue from the sale, and the value of the merchandise. They also lose the value of overhead costs like shipping, fulfillment, and interchange. Finally, the merchant is also forced to pay a fee for every chargeback.
Consumers tend to use credit and debit cards interchangeably. While there are a lot of similarities between the two, debit cards and credit cards each offer different levels of fraud protection.
In cases of credit card fraud, the cardholder’s liability is limited to no more than $50. Because the funds technically belong to the bank, not to the cardholder, the bank may be more invested in trying to recover the money.
In contrast, debit cards are tied to funds that actually exist in the cardholder’s account, rather than to a line of credit issued by the bank. Cardholder liability for debit card fraud is limited to no more than $500, assuming the cardholder reports the incident within 60 days. Otherwise, their right to recover funds is dependent on the bank’s judgement.
In the early 1970s—before all the above protections had been put in place—bank credit cards had not yet gained widespread acceptance in the US.
Consumers were hesitant to use payment cards. To be fair, they had good reason to be skeptical. It wasn’t hard to steal these early cards and use them for unauthorized transactions. If that happened, the legitimate cardholder could get stuck covering those bogus charges.
There were also complaints of merchants taking advantage of consumers. Some dishonest merchants inflated prices or added extra charges to a bill after the fact. The Fair Credit Billing Act of 1974 was an attempt to address these issues by creating chargebacks as we know them today.
The chargeback option protected consumers in two ways. First, it strictly limited consumer liability in cases of fraud. At the same time, it gave them the right to fight back against unfair or deceptive merchant practices.
The Electronic Funds Transfer Act provides similar protections for debit card users.
The federal mandate was designed to help relieve consumer fears. And, for the most part, it worked. Credit card use exploded throughout the US in the 1970s.
A half-century later, chargebacks are still an important consumer protection mechanism…at least, when they’re used as intended. Like we’ll see, however, that isn’t what’s happening.
Let’s look closer at the chargeback process itself. From the merchant’s perspective, stemming the flow of chargebacks is challenging, at best. There are multiple players and a lot of moving parts. Even worse, transactions can be disputed weeks or months after the actual sale.
The number of steps involved in the chargeback process will vary based on a lot of different factors. That said, here’s a basic rundown of how it works:
What if the merchant’s evidence doesn’t refute the cardholder’s claim? The transaction amount is permanently moved from the merchant to the cardholder, and the chargeback stands.
It may seem like merchants are basically being judged “guilty until proven innocent” here. In truth, that’s more or less the case.
Like we said before, though, chargebacks remain an important consumer protection mechanism. It’s just one that has been subverted in such a way that modern merchants are actually becoming the victims.
Today, credit cards are such a ubiquitous part of life that many users don't even realize they have chargeback protection. Those who know about chargebacks often fail to understand what is—and what isn't—a valid credit card chargeback use case.
Of course, there are situations where cardholders have every right to file a chargeback:
For lost or stolen cards, cardholders should contact the bank immediately to prevent additional losses. In almost all other cases, though, the cardholder needs to talk directly to the merchant before calling the bank.
Most accidents or innocent mistakes can be rectified with a simple call to the merchant. This is better for both parties. The merchant avoids a chargeback, and the cardholder gets their money back much quicker than they would with a chargeback.
Of course, a chargeback may be in order if the merchant isn't able—or willing—to work toward a mutually agreeable solution. It’s generally better for merchants if they cooperate, though.
Chargebacks may have been designed as a form of consumer protection, but industry regulations have not kept pace with payments technology. This allowed chargebacks to become weapons which consumers can use against merchants.
The internet and eCommerce have made shopping more convenient than ever. But, at the same time, filing a chargeback is also easier than ever. The anonymity of online transactions makes it difficult to fully validate buyer’s claims.
Learn to distinguish truth from fiction when it comes to chargebacks.
Because of chargeback abuse, merchants are now more likely to experience fraud coming from customers than from criminals. Friendly fraud—also called chargeback fraud—refers to situations where customers dispute legitimate charges. This can happen innocently or maliciously. The negative impact on the merchant is essentially the same either way, though.
There are multiple ways a cardholder might file a chargeback inadvertently. For example, if the cardholder:
That last one is highly relevant. Based on what consumers claim at the time of filing, nearly half of all chargebacks are blamed on “unauthorized transactions.” A survey conducted by Chargebacks911, however, found that 81% of cardholders filed a chargeback simply because they didn’t have time to request a refund from the merchant.
The 2021 Chargeback Field Report
The 2021 Chargeback Field Report is now available. Based on a survey of over 400 US and UK merchants, the report presents a comprehensive, cross-vertical look at the current state of chargebacks and chargeback management.
Friendly fraud is a serious problem. Keep in mind, however, that not all chargeback fraud is “friendly.”
Consumers deliberately abuse the chargeback process for a variety of reasons:
Cardholders might think a single incident of chargeback fraud is no big deal. It adds up quickly, though. Chargebacks will cost merchants approximately $117 billion annually by 2023. In reality, the costs could be even higher when accounting for false positives, and other sources of lost revenue. The majority of these losses will be the result of friendly fraud and chargeback abuse.
Chargebacks have both short and long-term ramifications for merchants.
If the merchant’s account is terminated, that business will be placed on the MATCH list. The business is blacklisted, and will be unable to secure a new bank account–even with a different service provider–for at least five years. Their only option will be to secure a high-risk merchant account… if they can get a bank account at all.
While merchants have the right to dispute illegitimate chargebacks, doing so is more difficult than it sounds. Crafting an effective dispute takes significant resources. Merchants rarely win DIY chargeback responses; according to our data, the average net recovery rate for chargebacks is just 12%.
Merchants aren’t the only ones who will suffer due to illegitimate chargebacks and friendly fraud. In the end, consumers may pay a price as well:
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For long-term change, both merchants and consumers need to be educated on chargeback protocols and best practices. Both parties also need to accept responsibility for their actions in the process.
Cardholders must remember that credit card chargebacks should only be filed in extreme situations. Chargebacks are a last resort; they should never be the first action to take when seeking a refund.
Also, more than one party may be responsible for a dispute. When this happens, the bank may issue a partial chargeback, giving the cardholder their money back for the portion of the transaction to which they’re believed to be entitled.
For their part, merchants must work to reduce the risk of chargebacks, both legitimate and illegitimate. Seeing a drop in friendly fraud may simply require providing prompt, transparent, and attentive customer service.
The right prevention tools will help, too. Implementing fraud detection strategies will enable merchants to identify more fraud incidents before they happen.
Finally, fighting invalid chargebacks is a must for merchants. It helps educate consumers about the proper use of chargebacks. Plus, banks issue fewer claims against businesses who regularly contest illegitimate cases.
With proper education and action, merchants and consumers can see a decline in the number of fraudulent chargeback claims, both now and in the future.
eCommerce technology is constantly evolving, and new chargeback threats appear daily. An effective chargeback management strategy must be flexible enough to identify new trends and techniques, counteract new technology, and adapt on the fly to a shifting landscape.
No one understands this better than the experts at Chargebacks911® . That’s why we offer the most comprehensive chargeback management services and products available. Our transparent, end-to-end solutions go beyond prevention to revenue recovery and future growth.
Whatever you need to fight chargebacks, we can help. Contact us today for a free demo.