Chargebacks are an inevitable part of payment acceptance and can happen for a number of reasons. More than 238 million chargebacks occurred in 2023.
As online transactions grow, so do the risks of fraud and errors. "Card-not-present" purchases lack in-person verification, which therefore increases the chance of disputes.
A report by Ethoca predicts that 337 million global chargebacks will occur annually by 2026.
While chargebacks impact many businesses, there are ways to prevent and minimize them.
In this blog, we will discuss the chargeback process, types and ways to mitigate them.
Definition of chargeback
A chargeback is a refund issued to a payment card (debit or credit card chargeback) after a customer disputes a charge on their statement.
Chargebacks were originally designed to protect customers from fraud and unauthorized transactions.
However, they can also be initiated for various other reasons, such as dissatisfaction with a product or service, non-receipt of a purchased item, or technical errors in the transaction process.
Difference between chargebacks and refunds
A refund is initiated by the business to return funds to the customer, while a chargeback is initiated by the customer’s bank or credit card provider.
Both return funds, but the key difference is who starts the process.
A bank chargeback occurs when anomalies are detected in transactions, leading the bank to manage the dispute between the issuer and acquirer. There are also other distinctions between the two.
With chargebacks, the issuing bank takes charge, managing communication between the customer and business.
Refunds are handled directly between the customer and the business, with the business initiating the fund reversal.
In refunds, the business controls the funds, deciding when to return them. For chargebacks, the customer’s bank pulls the funds from the business, holding them until the dispute is resolved.
Refunds typically take 3-7 working days, while chargebacks can take weeks or even months, especially if the business disputes the charge.
Why do chargebacks happen?
A chargeback can occur for several reasons:
- The customer doesn’t recognize the charge, possibly due to fraud.
- Goods or services weren’t delivered as expected.
- A promised refund hasn’t been received.
- Sale errors, such as double charging, wrong amounts, or charges after a subscription cancellation.
- Errors at the point of sale, like using an expired card.
During disputes, the funds in the cardholder's account can be temporarily held or withdrawn, affecting the cardholder's available balance.
Chargebacks may also happen if the bank disputes a transaction, such as when it’s unauthorized, the account is closed, or incorrect card details are processed.
Types of chargebacks
Chargebacks can be categorized into three main types: true fraud, friendly fraud, and merchant error. Understanding these categories can help businesses identify the root cause of chargebacks and take appropriate action.
True fraud
This occurs when a transaction is made without the cardholder’s authorization, often due to stolen credit or debit card information.
True fraud chargebacks are initiated to protect the cardholder from fraudulent transactions.
Friendly fraud
Despite its name, friendly fraud is anything but friendly for businesses.
It happens when a customer makes a legitimate purchase but later disputes the charge, often claiming they did not receive the product or service, or that the transaction was unauthorized.
This type of chargeback can be challenging to dispute, as it involves a legitimate transaction.
Merchant error
These chargebacks result from mistakes made by the merchant, such as processing errors, incorrect billing, or failure to deliver goods or services as promised.
Merchant error chargebacks can be minimized by ensuring accurate transaction processing, clear product descriptions, and reliable delivery methods.
By recognizing the different types of chargebacks, businesses can better understand the underlying issues and implement strategies to prevent them.
How does the chargeback process work?
Chargebacks begin after a transaction is complete, when the payment has been processed, and the charge appears on the customer’s credit card statement. Here’s how the chargeback process works:
- Customer begins a dispute: When a customer sees a charge they believe is fraudulent, they file a dispute with their issuing bank.
- Card issuer initiates the chargeback: The card issuer, which is the financial institution managing the credit card account, starts the chargeback process after receiving the dispute.
- Business can disprove the chargeback: The business is notified and has a chance to provide evidence proving whether the charge is valid. The cardholder may receive a provisional credit while the dispute is being investigated.
- Bank makes the final decision: The issuing bank reviews both sides and decides whether to approve the chargeback or uphold the business’s claim.
There are also regulations to protect the customer that need to be considered. For example, in the UK, the Consumer Credit Act provides legal recourse against unsatisfactory goods or services for purchases over £100 made with a credit card.
Who pays for a chargeback
When a chargeback is initiated, the issuing bank communicates through its processing network to the business’s bank, which authorizes the fund transfer with the business’s confirmation.
If a dispute is found to be valid, funds will be deducted from the business's bank account.
In cases of fraud, the issuing bank may grant a chargeback while investigating the claim, taking on the liability and absorbing costs through reserve funds.
Businesses are usually charged fees for chargebacks by their acquirer, outlined in the business's account agreement. These fees cover processing costs and may include additional penalties for chargebacks.
How much do chargebacks cost businesses?
Chargebacks result in lost revenue, as businesses must refund the purchase when a chargeback is granted.
The credit card company plays a pivotal role in resolving disputes, as they have specific timeframes to address disputes and make decisions, which can significantly impact customers facing issues with their chargeback claims.
Businesses also pay a chargeback fee to the card processor, even if they successfully dispute the chargeback. These fees can exceed the transaction value, with Mastercard estimating operational costs of $15 to $70 per dispute.
Additionally, businesses may be unable to recover the goods or services involved in the chargeback, especially in cases of fraud or digital products, further impacting their bottom line.
Understanding the chargeback process, reason codes, and threshold is crucial for minimizing the risk of chargebacks and protecting your business.
By implementing effective chargeback prevention strategies and responding promptly to chargeback claims, businesses can reduce the financial impact of chargebacks and maintain a healthy merchant account.
How to fight a chargeback in customer disputes?
Have a details response plan in place to deal with any chargebacks. When notified of a chargeback, first determine if it’s due to fraud or a customer service issue.
When a dispute is filed, the bank retrieves funds from the recipient's bank account to return to the cardholder's account.
When a customer initiates a chargeback, businesses have about 30 days to respond, depending on the payment processor.
During this time, businesses can gather evidence —such as receipts and delivery confirmations—to dispute and prove the chargeback is an error.
If discussions with the customer fail and you’re confident in the transaction’s legitimacy. Your payment processor will typically handle communication with the customer’s bank, and you’ll wait for their decision on the chargeback.
If the charge is indeed fraudulent, inform the customer’s issuing bank that you won’t contest the chargeback and that funds should be returned. Also, notify your payment processor about the fraud to assess if it’s an isolated incident.
If no fraud actually occurred, engage directly with the customer to resolve their concerns. Many disputes can be settled through communication, potentially avoiding a chargeback.
Even if a refund is necessary, it’s often preferable to a chargeback for businesses.
How to prevent a chargeback claim?
Clear Communication and Transparency: Providing good customer service and ensuring you have transparent pricing and terms will go a long way to preventing chargebacks before they are even initiated.
Document Customer Interactions: Keep records of all customer conversations as evidence for potential disputes.
Display Business Name Clearly: Ensure your business name appears correctly on customer receipts and bank statements to help customers recognize their payments.
Establish a Clear Returns Policy: A fair and transparent returns policy encourages customers to follow standard procedures instead of resorting to chargebacks.
Customers are protected against debit card fraud through debit card chargebacks, which limit their liability for fraudulent transactions and provide a process to reverse unauthorized charges.
Provide Accurate Product Descriptions: Detailed descriptions set realistic expectations, reducing confusion and dissatisfaction.
Fraud Prevent Tools: Advanced tools that track customer spending patterns and flag unusual transactions, and/or perform KYC/KYB checks go a long way to preventing chargebacks.
Conclusion
Chargebacks are a significant concern for businesses, initiated by customers through their banks to dispute transactions. This can be a debit or credit card chargeback.
Understanding the differences between chargebacks and refunds is essential, as well as the reasons they occur and the processes involved.
While chargebacks can result in lost revenue and additional fees, businesses can mitigate their impact by implementing effective preventive measures and maintaining clear communication with customers.
By proactively addressing potential disputes, businesses can protect their bottom line and foster better customer relationships.
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