How the Payment Industry Defines Chargebacks and What Merchants Need to Know
Chargebacks are an important part of the credit card payment process. A thorough understanding of the chargeback definition, including how and when they should be used, is essential to protect both the consumer and merchant.
How to Define Chargeback Protections
Chargebacks affect both merchants and consumers, creating a double-edged sword that can protect as well as destroy. Understanding the definition of chargeback can help prevent revenue loss and other problems for merchants, as well as keep consumers from participating in fraudulent activity.
Chargebacks, in essence, are a forced credit card refund processed by the cardholder’s issuing bank. Either the consumer or bank instigates these refunds.
- A cardholder can contact the bank to dispute a transaction.
- The issuing bank may dispute the charge based on a merchant error that occurred while processing the transaction.
Regardless of who initiates the transaction dispute, a chargeback voids the purchase and debits the merchant’s account.
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Chargebacks were originally designed to be a safety measure for cardholders who may have been taken advantage of by fraudulent merchants or had their credit card account information compromised by criminal activity.
Chargebacks are a warranted consumer protection mechanism in these specific circumstances. In the case of an unscrupulous merchant, for example, the cardholder has no other recourse than to file a chargeback with the bank to recoup transaction costs. Similarly, criminal activity leaves a consumer with few options outside of the chargeback process.
Reasons for Chargebacks
From the bank’s perspective, there are numerous valid reasons that encompass the chargeback definition. Cardholders can claim merchant errors, shipping problems or faulty products, to name a few.
The bank assigns a reason code to the chargeback, telling the merchant why the transaction was disputed.
However, the reason codes assigned to chargebacks don’t often reflect the real motive for disputing a transaction.
Chargebacks fall into one of three categories: criminal fraud, merchant error, and friendly fraud. Many times, a merchant tries to managed chargebacks based on the given reason code—which usually implies criminal fraud or merchant error.
In reality, the vast majority of chargebacks are cases of friendly fraud.
When Chargebacks Go Bad
In spite of the chargeback definition, cardholders have become accustomed to the ‘no-fault’ policies that many card issuers offer their customers.
As a result, consumers have begun to use the chargeback process as a personal concierge service, designed to make their shopping experience easier. Cardholders who wish to return items past the ‘return by’ date, who simply don’t want to be bothered to make the return, or who are looking to get something for free have all found ways to manipulate the chargeback process.
An unwarranted chargeback amounts to cyber shoplifting. The practice is commonly known as "friendly fraud," and unfortunately, the popularity of friendly fraud is growing at an alarming rate. Merchants who are unable to accurately identify the true reason for the transaction dispute will forever be implementing incorrect and inefficient management strategies.
The Cost of Chargebacks
While the process seems simple and straightforward, the reality is that a chargeback can wreak havoc with a merchant account and severely impact cardholders.
Each chargeback is accompanied by a fee. These fees vary based on the merchant account and processing agreement. However, most merchants pay between $20 and $100 for each chargeback.
Before issuing a merchant account, the acquirer assesses the business’s perceived risk. Merchants who are deemed to be high risk pay increased fines and have restricted access to revenue.
Chargeback rates are influential in calculating risk.
Acquiring banks also monitor risk throughout the duration of the processing agreement.
If chargeback rates escalate and become excessive, the acquiring bank will be forced to take action. Each card network has its own chargeback thresholds, but acquirers usually terminate processing agreements long before networks demand action.
It is essential for merchants to understand how chargeback management can impact the business’s longevity and sustainability. The terms associated with high risk accounts can easily drive a merchant out of business, that is, if the merchant is even able to secure another account after a processing agreement is terminated.
When a chargeback is issued, merchants have two options: accept it or fight it.
While many merchants feel as though fighting chargebacks is cost-prohibitive, the reality is that merchants can’t afford to not fight a chargeback.
In addition to the lost merchandise and earning potential, merchants are penalized with fees for each chargeback. As a result, chargebacks are very costly to merchants.
Disputing illegitimate chargebacks (cases of friendly fraud that never should have been authorized by the issuing bank) does two things. First, it recoups lost revenue—money that shouldn’t have been revoked in the first place. Second, it helps improve the merchant’s reputation and prevent future chargebacks.
Banks operate on a ‘guilty until proven innocent’ system, assuming that if a chargeback was filed, the merchant is at fault. Disputing chargebacks provides merchants with the means to repair their reputation, as well as protect their profit.
By taking a proactive approach to chargeback management, merchants can reduce their chargeback exposure. It isn’t necessary, or advisable, for merchants to live in a defensive mode, only reacting to chargebacks. Prevention is possible!
- Writing a Return Policy to Avoid Chargebacks
- Avoid Chargebacks Associated with Authorization Errors
- Using Authorization Holds to Prevent Chargebacks
- Best Ways to Prevent Card-Not-Present Chargebacks
- What are the Best Chargeback Prevention Tools Available?
- Five Surefire Ways to Prevent Chargebacks and Retain Revenue
- The Best Management Strategies to Avoid Transaction Disputes
- 35 Simple Steps to Preventing More Chargebacks
Understanding the definition of chargebacks can be time-consuming and overwhelming. However, it is an essential task. Chargebacks needlessly steal time and revenue; merchants must defend their assets.
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