What are chargebacks? A complete guide for startups

A chargeback is a mechanism to reverse a card payment directly with the payment card provider to get money back that the consumer believes should not have been taken.

Chargebacks occur in several instances, including when goods are faulty, card payments are taken incorrectly or duplicated, a payment is deemed fraudulent, goods/services haven’t been provided, or a payment that should have been cancelled has been taken.

Chargebacks are a pain point for retailers because, often, they’ll just see a payment reversed from their bank account without knowing why. This is because customers who use chargebacks will contact card providers, not the retailer themselves.

In this article, we’ll cover what a chargeback is, why customers file them, how they’re processed, the impact on businesses, and how you can dispute them.

What is chargeback?

A chargeback is a bank-enforced payment reversal where a customer’s card issuer withdraws funds directly from a retailer’s bank account to resolve a disputed debit or credit card transaction.

The bank or card provider then requests the funds from the retailer’s bank account and, if the chargeback is agreed, returns them to the customer’s account. If not, the funds are returned to the retailer.

Card issuers do not guarantee fund recovery, and retailers retain the right to dispute invalid chargebacks by providing transaction evidence.

When a customer initiates a chargeback, it does not mean the card issuer accepts joint liability. Claims are made to the bank that provides the debit or credit card, which then makes a request to the retailer’s bank.

Chargeback vs Refund: What’s the difference?

While chargebacks and refunds both result in money returning to the customer, they ultimately serve different purposes.

A refund is initiated by the business and involves returning the purchase amount to the customer. This is usually due to dissatisfaction, returns, or cancellations. These are a natural part of business operations and, when managed correctly, can help to maintain customer trust and satisfaction.

On the other hand, a chargeback is when a customer disputes a transaction directly with the bank, often due to unauthorised or fraudulent transactions. The bank then reverses the transaction, returning funds to the customer and initiating an investigation into the matter.

Chargebacks can lead to financial strain, administrative burden, and potential damage to your business’s reputation, especially if they’re not handled appropriately. Refunds, while more controllable, might affect cash flow temporarily but contribute positively to customer satisfaction and trust.

Why do customers file chargebacks?

Customers primarily file chargebacks due to unauthorised fraudulent charges, unfulfilled orders, damaged goods, or unresolved merchant disputes.

Customers also initiate chargebacks to get a refund when they feel the payment is not justified. For example:

• An unauthorised transaction
• The merchant failed to cancel a payment after the customer asked them to
• The goods ordered were not received
• The goods ordered were damaged or not as described

A final reason for chargebacks is genuine criminal fraud – for instance, if someone’s card is stolen and used to make purchases.

How are chargebacks processed?

Chargebacks are typically processed when the customer’s bank or credit card provider reverses the payment from the business and holds the funds until the dispute is resolved.

A chargeback can only occur after the initial transaction is completed and the charge is made to the consumer’s card. The process tends to go as follows:

1. The customer files a dispute with the issuing bank, which initiates the chargeback.
2. The affected business can dispute the chargeback and provide evidence to support their defence.
3. The bank or card issuer reviews the evidence to decide whether the chargeback should proceed. If no evidence is submitted, the decision will usually go in the customer’s favour.
4. The card issuer will update the consumer and the business about the progress of the chargeback claim. If the charge is deemed valid, the funds are returned to the retailer. If the chargeback is valid, the funds are credited back to the consumer.
5. If the business or the customer is unhappy about the decision, they can enter an arbitration process, with the final decision made by the card network.

How do chargebacks affect businesses?

Chargebacks directly reduce business revenue through lost sales, non-refundable merchant processing fees, potential card issuer penalties, and customer churn.

Chargeback fees are typically around £15-£25, but can also go up to £100 or more. Customers who initiate chargebacks without giving the merchant a chance to resolve the problem can also hurt businesses.

With refunds, the retailer controls the decision to some extent. With chargebacks, it is the customer’s bank and eventually the card issuer who decides. The funds are pulled from the retailer while a decision is made. If the decision goes the way of the customer, this means a lost sale and reduced profit, as well as fees.

Plus, if a business suffers too many chargebacks, card issuers may place restrictions or impose higher fees on their business transactions. Chargebacks also cause more administrative work and even reputational damage in some cases.

What scams are common with chargebacks?

Because card issuers handle dispute decisions directly, businesses often face an asymmetrical resolution process with strict evidence deadlines.

Claiming a chargeback for a legitimate purchase is fraud, but consumers are increasingly using chargebacks for “friendly fraud” to quickly get a refund in response to issues like:

• A payment made in error
• Delivery problems
• Administrative errors
• Payments processed with a technical mistake
• Recurring payments or subscriptions that have not been cancelled
• An unresolved customer complaint

From a customer point of view, this strategy is often used to bypass poor and time-consuming returns policies and customer dispute resolution processes. In many “friendly fraud” cases, chargebacks could be avoided if customers talked to the business about the problem.

How to minimise chargebacks

To minimise chargebacks, businesses must maintain transparent pricing, clear return policies, automated order tracking, and fast customer service responses.

Businesses need to be proactive and implement effective customer service and clear, transparent, and easy-to-use returns policies. Here are some ways you can reduce chargebacks as much as possible:

• Encourage customers to contact you to resolve issues quickly, and respond effectively when they do
• Have clear rules detailing your returns policy, which are effectively communicated and displayed to customers
• Make the returns process as easy as possible
• Confirm customer orders and provide receipts with the total price
• Give tracking information on all orders and use a reliable, vetted shipping service
• Use fraud prevention software so any suspicious orders get blocked
• Check the chargeback and fraud prevention policies of payment processors like Stripe, PayPal, etc. before signing up with them
• Process transactions quickly and accurately, and keep records of every sale
• Ensure card payments are secure and that customers details aren’t at risk of being compromised
• Train staff to follow card acceptance rules and best practices
• Respond quickly to customer returns queries
• Make sure your recognisable business name is shown on card and bank statements

How to dispute invalid chargebacks

When you’re notified of a chargeback, the first step is to find the source transaction and understand what happened, what the customer is disputing and why, and then decide how to respond.

If it looks like a legitimate chargeback claim linked to fraud, let the customer’s card issuer know you won’t dispute the claim and are happy for the payment to be returned to the customer. You should also inform the payment processor so they can find out whether it’s part of a wider issue.

If the chargeback claim is not fraudulent, but was initiated by the customer as part of a “friendly fraud” claim, you will need to dispute the claim.

Initially, you should contact the customer to try to resolve the issue before the dispute is escalated. If you end up having to refund them, that’s a better outcome than a chargeback, and you may retain the customer for the future.

If you still need to dispute the claim, gather evidence to support your position. This could include:

• Receipts
• Order numbers
• Delivery confirmation
• AVS/CVV matches
• IP logs

The payment processor will send this evidence to the card issuer for them to investigate and decide.

Conclusion

Chargebacks are becoming an increasingly common challenge for businesses, with some consumers turning to “friendly fraud” rather than going through lengthy or complicated refund and return policies.

That’s why reducing chargebacks is so important, as they can result in financial losses, administrative burdens, and damage to customer relationships. Still, businesses can lower the risk by setting clear refund and return policies, improving communication with customers and making the payment process as transparent as possible.

Overall, implementing preventative measures and maintaining sufficient evidence to support legitimate transactions can help businesses better manage disputes and protect their revenue.