What is a Chargeback?

February 15, 2021/ Jarrod Wright /

Chargebacks are often misrepresented and used interchangeably by cardholders with refunds. True, the consumer receives their money back in the end, but the two terms have vastly different meanings.

To fully understand where chargebacks come from and how they negatively affect merchants, let’s start at the beginning. A chargeback is a forced transaction reversal initiated by the cardholder’s bank. The process was first introduced several decades ago. The Fair Credit Billing Act of 1974 required card brands to have a method in place to help consumers recover their funds in the case of fraud or abuse.

Unfortunately, there wasn’t much in the way of actual guidance on how to do so. In response, card networks like Visa and Mastercard developed their own chargeback rules.

The introduction of credit cards left many consumers wary, and with the chargeback system a new layer of protection was added. The chargeback process was intended to be used as a last resort when cardholders fell victim to criminal fraud or merchant abuse. The expectation was that the cardholder would have exhausted every avenue in resolving the situation directly with the merchant before filing a chargeback.

Since then, though, consumers have learned how to abuse the system to the detriment of merchants everywhere.

The True Cost of Chargebacks

If left unchecked, chargebacks have the power to wreak havoc on a merchant’s bottom line. The following list is a bird’s eye view of the negative impact chargebacks have on merchants:

• The merchant must pay a fee (anywhere from $20 to $100) for every chargeback that is filed against the business. Even if the consumer changes their mind and later cancels the chargeback, the merchant is responsible for paying the fees and administrative costs associated with the process.
• After filing a chargeback, a consumer is unlikely to return the merchandise involved. Not only does the merchant lose their up-front investment in the merchandise, they also lose the chance to resell in the product in the future.
• The shipping costs and transaction processing fees are not refunded after a chargeback. The merchant loses these costs on top of the merchandise mentioned above.
• In the event where the monthly chargeback rate exceeds a predetermined chargeback threshold, the card network can enforce fines to punish the business. The longer the merchant remains noncompliant, the more these fines can grow.
• If the merchant’s chargeback rate remains above the acceptable threshold, the merchant’s acquiring bank could decide to terminate their account. The business’s funds would freeze, and they would be unable to accept card payments.
• When a merchant’s account is terminated by the acquirer due to chargebacks, that business is added to the MATCH list. Essentially, this is a blacklist that makes it impossible to secure a new account with a different processor for at least five years.

As we’ve seen, chargebacks have devastating consequences that can cripple a merchant’s business.

3 Chargeback Sources

Each time a cardholder files a chargeback, card networks are required to assign a code explaining the basis for the dispute. For example, Visa has around two dozen chargeback reason codes. The problem here is that though reason codes can be used to help merchants see why a chargeback was filed, they don’t show the full picture.

Reason codes aside, all chargebacks can be traced back to three fundamental sources:

• Merchant Error. These account for 20-40% of all chargebacks filed. Merchant errors can be any minor missteps in the merchant setup, transaction data, order processing, or customer service.
• Criminal Fraud. Contrary to what many might assume, criminal fraud accounts for less than 10% of chargebacks. This includes identity theft, stolen payment cards, or any cybercrime that results in a cardholder’s payment information being used without permission.
• Friendly Fraud. This accounts for 60-80% of all payment card chargebacks. Friendly fraud is the abuse of the chargeback process by cardholders, whether intentional or accidental.

While merchant error and criminal fraud constitute valid reasons for disputing a charge, friendly fraud covers any situation where the customer files a chargeback that is not in line with the spirit of the chargeback’s definition as a consumer protection tool.

It all begs the question, what can merchants do to protect themselves?

It Begins with Chargeback Prevention

If a merchant intends to fight a dispute, they must prove that a chargeback was invalid by providing compelling evidence during a process called representment. However, there’s no guarantee of success, which is why the best approach is to prevent chargebacks from occurring in the first place.

Merchants should review their policies and procedures at every step of the transaction process to identify and eliminate merchant error. On the criminal side, it’s important to adopt a comprehensive and multi-layer fraud strategy.

There are numerous tools available that should be implemented and used in conjunction with each other:

• CVV verification
• Address verification (AVS)
• Geolocation
• 3-D Secure 2.0 technology
• Velocity checks
• Biometrics (when applicable)
• Fraud blacklists

Unfortunately, the majority of disputes are not valid. Chargeback abuse is costing merchants billions of dollars a year, and it shows no sign of slowing down. The only way merchants can effectively identify, manage, and prevent chargebacks is by understanding where they’re coming from and implementing a comprehensive strategy to tackle them head-on.

Last Update: February 15, 2021