What is payment chargebacks and how to reduce the risks of chargeback?

A chargeback provides consumers with a safeguard against fraud by allowing them to dispute transactions made through debit or credit cards. Through this process, customers can return funds they believe were wrongly taken from their account due to unapproved or fraudulent usage of their card details.

Typically, disputes or chargebacks are of the following three types: .

Types of Chargebacks

Typically, disputes or chargebacks are of the following three types:

1. Merchant Error:

   In this type of dispute, the merchant mistakenly charges a customer's card for a product that the customer cancelled or didn't order. To tackle this, you can integrate tools that ensure secure transactions or help spot fraudulent or suspicious transactions. You can look for suspicious patterns and put a hold on the transactions mid-way before letting them complete. Dispute management tools might also help.

2. Friendly Fraud:

   In this case, the customers file a dispute without asking the merchant for a refund. Usually, cardholders/customers dispute a perfectly legitimate transaction on their card to get a refund from their issuing bank to avoid paying for a product.

3. Criminal Fraud:

   This dispute type is probably the primary reason why chargebacks were created. It happens when a criminal/fraudster charges a customer's card to make transactions.

Now that you know what chargebacks are, let's learn how they work, why merchants dislike them, and how to avoid them.

Good read: What Is a Payment Processor and How Does It Work?

How do Chargebacks Work?

Here's how chargebacks work:

• Processing of transaction: The customer purchases from your business using a debit or credit card. The transaction is processed, and you receive the payment in your merchant/business account.

• The customer disputes it: The customer gets notified of the transaction and files a dispute with the issuing bank for whatever reason they find appropriate.

• Chargeback process begins: The bank that issued the credit card to the customer gives them a temporary credit and contacts your payment processor to initiate the chargeback process. 

• The merchant's account has been debited: Once the payment processor knows about the chargeback, disputed funds will be temporarily debited from your account until there's a resolution. And you'll be notified of the same. 

• Chargebacks can be rebutted by the merchant: As a merchant, you have the power to supply the required documents and rebut the dispute or chargeback. However, if you fail to submit the documents after being notified, the issuing bank will rule the case in the customer's favor.

• Issuing bank makes a decision: In case you facilitate the documents necessary for rebuttal, the issuing bank will analyze them and make a decision. If it's in your favor, the funds will be credited to your account, and the customer must pay.

• Arbitration possibility: If you or the customer aren't happy with the decision ruled out by the issuing bank, an arbitration process can be initiated. In that case, the chargeback/dispute is taken to the card network, such as American Express, Visa, etc., for the final call.

Why do Merchants Dislike Chargebacks?

Here's why:

• Loss of sale: If a chargeback is filed for all the right reasons, merchants lose all the funds from the sale, impacting the business's bottom line.

• Chargeback Fee: The payment processors charge a fee for resolving the chargebacks, which is to be covered by the merchant. While the chargeback fee usually ranges from $15-50 per transaction, it could also cross $100. And this can be detrimental to the business's bottom line.

• Additional Fee: Usually, credit card networks have a set number of acceptable chargebacks for merchants. If you cross that number, the card network may place your business in a monitoring program. And because of this, you may have to pay additional fees and monthly fines.

• High-Risk Category: A merchant with a high number of chargebacks could be classed as high-risk. And payment gateways charge a higher fee from such merchants.

Now that you know how chargebacks work, let's learn how to prevent them.

How to Identify the Root Causes of Chargebacks? 

While each chargeback has a unique reason, they essentially fall into one of the below-mentioned categories. If you know which category the chargeback falls into, you can quickly determine what’s the reason behind that chargeback:

1. Fraud

When the cardholder claims that they didn’t initiate or authorize the transaction, most probably, a scammer is behind that.

2. Customer Disputes

Another category of reasons behind chargebacks is consumer or customer disputes. They happen when the customer raises a dispute citing reasons such as:

• The delivered product wasn’t as described
• The product was delivered late.
• The payment wasn’t processed.

3. Authorization 

Chargebacks arising because the cardholder failed to authorize the payment or the authorization was declined come under the category of ‘authorization.’

4. Processing Errors

Sometimes customers raise chargebacks because of incorrect payment information such as account number or currency.

Good Read - Voluntary vs. Involuntary Churn: Understanding the difference

How to Reduce Chargebacks?

Here’s how merchants can prevent or reduce the risk of payment chargebacks:

1) Explicitly Define Your Return, Refund, and Cancellation Policies

You should have a clear return, refund, and cancellation policy. Customers should know they can easily return a received item, file for a refund, or cancel the product. This way, you can significantly reduce the instances of chargebacks for transactions wherein:

• The transaction amount is incorrect.
• The transaction is canceled, but the customer is still charged.
  
  

2) Offer Order Confirmations

Online merchants should always offer order confirmation once the customer places the order. Also, let the customers track their orders and inform them of potential delays. In addition, customers should have the option to purchase an alternative product or cancel their order. This will help you prevent the most common payment disputes:

• Merchandise not received
• Service not provided
  
  

3) You Should Be Easy To Approach

A significant reason customers approach the issuing bank for chargeback is the difficulty in contacting the merchant. Therefore, make sure that you're easy to approach. To do that, you can reduce customers' steps to chat or talk to a live agent. This way, you can prevent the matter from escalating and, thus, reduce chargebacks.

4) Use an Explicit Billing Descriptor On Customer Statements

Quite often, customers dispute a transaction just because they don't recognize it in their transaction. And this usually happens because the transaction description is too brief. However, you can avoid this by using a clear billing descriptor. If the customers recognize their transaction, they won't dispute the payment.

5) Delay The Billing

Sometimes, the purchase transaction appears in the customer statement before they've actually received the product. And this motivates the customers to file a "non-receipt of merchandise" dispute. To avoid this, you can start charging the customers only when the item is shipped. 

6) Always Collect Proof of Customer Participation

You can defend illegitimate chargebacks when you have evidence that the customer actually participated in a transaction. So, collect crucial transaction information such as order history, customer's IP, signature on the delivery receipt, and more.

7) Use Strong Customer Authentication Rules

Use protocols like 3DS2 to identify and verify customer identities. This way, you can prevent your business against criminal fraud wherein the customer's card is charged by a hacker/fraudster.

8) Cancel Recurring Transactions Promptly

Cancel all recurring transactions instantly and inform the customer about the same. This will help prevent customer disputes about being charged for a service they didn't use.

9) Update Expired Cards

Trying to charge expired cards can lead to payment declines and potential chargebacks from customers. Therefore, ensure you have up-to-date card information, and that expired cards are removed.

10) Reach Out to Your Payment Service Provider

PSPs usually have effective chargeback prevention and management systems that monitor transactions for potential fraud. Also, such solutions offer you all the evidence you need to contest chargebacks. Moreover, using risk assessment tools, PSPs can help you identify and detect fraudulent transactions and minimize the instances of chargebacks.

How Long Does It Take to Solve a Chargeback?

There isn’t a set duration within which a chargeback request will be solved as it depends on factors such as the reason code, chargeback type, the card network, etc. However, it takes around 1-3 months for a chargeback request to get solved.

Conclusion

As eCommerce technology evolves, new chargeback threats keep showing up. However, if you stay updated, use the latest tools, and determine the root cause of chargebacks, you can minimize the impact of chargebacks on your business. So, what are you waiting for? Follow the tips mentioned in this article and minimize the risk of chargebacks.