What are chargebacks? A complete guide for startups

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

Chargebacks occur when faulty goods are sent, when a credit or debit card payment is taken incorrectly or duplicated,  when a card payment is deemed to be fraudulent, when the service or goods paid for haven’t been provided, or when a payment that should have been cancelled has been taken.

In some instances consumers initiate chargebacks when there has been a dispute with a retailer.

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 chargeback will contact card providers, not the retailer themselves.

This article will cover what chargeback is, why customers file chargebacks, how chargebacks are processed, how chargebacks affect businesses, what costs, scams and disputes are common with chargebacks, how businesses can avoid chargebacks, and how to dispute chargebacks.

What is chargeback?

A chargeback is a type of payment reversal that reverses a debit or credit card payment as a result of a customer disputing the payment with their card issuer. The bank or card provider then requests the funds from the retailer’s bank account and, if the chargeback is agreed, returns it to the customer’s account. If not, the funds are returned to the retailer.

That said, there are no guarantees the card issuer will recover the funds, or that the retailer will accept the chargeback. It depends on the circumstances, and sometimes a business can successfully argue that the customer is in breach of the contract by not paying.

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

Why do customers file chargebacks?

Chargebacks were introduced to allow customers to reverse transactions caused by fraud, and this remains a common trigger for chargebacks.

Customers also initiate chargebacks to get a refund when they feel the payment is not justified – for instance, when:

• The transaction was unauthorised
• 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

“Most customers file chargebacks because of misunderstandings between them and the vendor,” Lev Tretyakov, CEO and Head of Sales at ecommerce business Fortador, told us. “This could be because the price is different or if goods take too long to ship because an item was out of stock.”

Customers increasingly use chargebacks to avoid time-consuming returns processes or customer dispute resolution processes, despite it not being the appropriate method to get money refunded. This is known as ‘friendly fraud’, which we’ll cover in more detail later in the article.

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 different to refunds. A retailer approves a refund and the money is returned to the customer by them. With chargebacks, 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, who 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 are unhappy about the decision, they can enter an arbitration process, with the final decision made by the card network.

How do chargebacks affect businesses?

Valid chargebacks cost businesses, not just through the lost sale but also potentially losing future business from that customer. There are also chargeback fees, which depend on which card issuer and payment processor is involved.

“Chargebacks are a dread for us because it means we lose money,” said Tretyakov. “Also, when there are too many chargebacks, customers might consider you unreliable, which is bad for business.”

The fact that customers initiate chargebacks directly with their card provider, usually without giving the business an opportunity 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.

Other pain points include the fact that chargebacks cause more administrative work, and can cause reputational damage.

‘Friendly fraud’ cases are also annoying for businesses, because the chargebacks could be avoided entirely if the affected customer contacts the retailer first to resolve the problem, rather than going directly to the card issuer to reverse the transaction.

What scams are common with chargebacks?

The chargeback process can be seen as ‘rigged’ against businesses because they have little to no control over it. The customer has nothing to lose, and card issuers would rather not have to deal with the problem.

Claiming a chargeback for a legitimate purchase is fraud, but ‘friendly fraud’ chargeback cases are an increasing problem for businesses.

However, consumers are increasingly using chargebacks in a technically ‘invalid’ way, known as ‘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.

As more consumers make borderline or fraudulent chargeback claims, card issuers must use extra resources to deal with them.

How to minimise chargebacks

“The best way is to respond fast,” said Tretyakov. “Always ensure you are clear about the prices, product description, and return policies to avoid misunderstanding.”

Businesses need to be proactive and implement effective customer service and clear, transparent, and easy-to-use returns policies. To minimise chargebacks, you should:

• 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
• Provide customers with receipts
• 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
• Ensure card payments are secure
• Train staff to follow card acceptance rules and best practices
• Respond promptly to customer returns queries
• Make sure your recognisable business name is shown on card and bank statements

How to dispute chargeback claims

Businesses should write a policy for how to prevent chargebacks from happening and how to dispute them, if appropriate, when they do.

When you’re notified of a chargeback, you should 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, dispute the claim.

Initially, you should contact the customer to try and resolve the issue before the dispute is escalated. If you end up having to refund them, that’s a better outcome than 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 – anything that can help prove the sale was genuine. The payment processor will send this evidence to the card issuer for them to investigate and decide.

Are chargebacks more common for online only businesses than for shops?

Online or ecommerce transactions do result in a higher proportion of chargebacks than those in bricks and mortar stores.

There are various reasons for this. Big ecommerce businesses like Amazon have successfully initiated free shipping and returns, and consumers expect other online retailers to follow suit. When customers don’t have to cover the costs of delivery and returns, they’re more likely to make a purchase without being certain they have exactly the right product. This inevitably increases the chance of ‘friendly fraud’ chargebacks.

Also, online businesses have extra steps within the purchasing process. Unlike in a physical store, where a customer enters the shop and leaves with the goods, shipping is an additional factor. Customers are more likely to initiate chargebacks for goods they have not physically seen or tried on when buying online.

This means it’s more likely they will find the goods not as described. There is also an increased chance that items can get lost, damaged, or delivered to the wrong address during the shipping process, which increases the likelihood of a chargeback.

However, chargebacks affect both ecommerce and in-person shops, so both types of business need to put measures in place to reduce chargebacks.

Conclusion

Chargebacks are an increasing problem for businesses, as time-poor consumers opt to take chances on ‘friendly fraud’ chargebacks rather than go through what can be laborious returns processes.

Businesses need to minimise chargebacks because they cost money, take up time, and can mean lost customers. To do this, businesses need to offer a clear returns policy and flexibility.

Chargebacks affect online businesses more than bricks and mortar businesses because their transactions comprise more factors and processes that can go wrong, but all businesses need to adopt strategies to reduce chargebacks and be able to dispute them effectively if necessary.