As a business owner, the last thing you want is a dispute with a customer. Unfortunately, with the increased incidence of chargebacks due to “friendly fraud,” businesses are at a greater risk of losing money from customers who opt to file a dispute with their bank instead of working directly with merchants to resolve the issue or receive a refund.
In This Guide
A chargeback, also called a payment dispute, is a reversal of funds after a customer has issued a dispute on a credit or debit card transaction with their bank. After the customer has filed a dispute with their bank, the bank initiates the chargeback process, holding the disputed transaction funds until they determine what to do with them.
If the bank rules in favor of the customer, the funds are returned to them from your merchant account or business bank account. If the bank rules in favor of the business, the disputed funds are returned to your account.
The concept of a chargeback was created by the Fair Credit Billing Act as a consumer protection mechanism against fraudulent charges. As time has progressed, however, chargebacks have become much more problematic.
How Does a Chargeback Work?
Overall, the chargeback process works like this:
- Purchase: A purchase is made from your business using a credit card.
- Processing: The transaction is processed and you receive the funds from your payment processing company.
- Customer disputes the charge: The customer sees the transaction and files a chargeback with their credit card company.
- Chargeback process begins: The issuing bank (i.e the bank that issued the credit card) initiates the chargeback process.
- Merchant can refute the chargeback: Next, the issuing bank reaches out to your bank, the merchant bank, and asks for any documentation to refute the chargeback. If your bank does not respond to the chargeback notification, the issuing bank typically grants the dispute to the customer and pulls the funds from your account, returning them to the customer.
- Issuing bank makes a decision: On the other hand, if documentation is provided to dispute the chargeback, the issuing bank then has to evaluate the evidence and make a decision about whether or not the chargeback is valid.
- Funds are returned to the customer: Again, if the issuing bank sides with the customer, they’ll take the funds from your account and credit the customer.
- Or—the customer must pay or start arbitration: If the bank sides with you, the merchant, the customer is contacted and then they must pay for the charge or opt to enter an arbitration process. With arbitration, the chargeback dispute is taken to the credit card company (Visa, MasterCard, American Express, etc.) and they review the incident and issue a final decision on the matter.
Although chargebacks are typically initiated by consumers, businesses technically have the ability to initiate the process as well.
In this case, you would reach out to your credit card processing company, or acquiring bank, with the request. Then, your payment processor would contact the customer’s credit card processing network to send payment from your merchant or bank account to their credit card account.
Chargeback vs. Refund
At this point, you might be wondering, “Is a chargeback a refund?” In short, the answer is no—although both chargebacks and refunds can involve the returning of funds to a customer, there are important differences between the two.
- Who initiates the process: Although you, as the business owner, could technically initiate the chargeback process as we described above, what you’re really doing, in that case, is issuing a refund. Therefore, whereas a business owner initiates a refund to repay a customer who is returning a product or is dissatisfied with your goods or services, customers initiate chargebacks through their issuing bank.
- Who the customer deals with: Another difference between a chargeback vs. refund is that the issuing bank facilitates the chargeback process on the customer’s behalf. With refunds, on the other hand, the customer works directly with the merchant to resolve the problem and collect their payment.
- What happens to the funds: With a chargeback, the issuing bank collects the disputed funds from your merchant account and holds them until a decision is made regarding the chargeback. In other words, the issuing bank has control over the funds. With refunds, however, you’re initiating the process and asking your payment processor to take the appropriate funds and return them to the customer.
- How long the process takes: Even though some customers file a chargeback out of convenience—as opposed to dealing with the perceived hassle of the refund process—chargebacks actually take much longer to process and resolve than refunds. Although there is some variation, chargebacks are typically resolved in a few weeks, but can take 75 days or more. Conversely, refunds generally take three to seven business days.
It’s also worth noting that a chargeback is different from a voided transaction, sometimes called a voided charge. With a voided charge—the transaction is cancelled before it settles with the customer’s debit or credit card account.
As an example, if you accidentally charge a customer twice for a single item and notice immediately, you can void the transaction through your POS system, thereby cancelling it before it’s cleared the customer’s account.
Perhaps one of the biggest problems associated with chargebacks are the fees you often face. In short, chargeback fees are incidental fees that your payment processor may charge each time one occurs. Typically these fees can range from about $20 to $50, but may reach up to $100, depending on your payment processor.
While some processors will charge a flat fee for each chargeback you incur, others will charge additional fees associated with the process of researching and disputing the chargeback on your behalf.
As an example, the merchant account provider Payline Data charges $25 per incidence of chargebacks, whereas PayPal charges a $20 fee, and Stripe charges a $15 fee. Generally, more expensive chargeback fees are associated with older, more traditional merchant service providers that are historically known for charging extraneous and hidden fees.
Luckily, with the growth of the merchant services industry, these fees have become more transparent—but they haven’t completely disappeared. It’s also worth noting that many providers impose larger chargeback fees on businesses that are considered high-risk—either because of their industry or their chargeback history.
Therefore, before you commit to a merchant services provider, carefully read the fine print of any agreement, as well as talk to a representative, in order to find out how the processor handles chargebacks, what tools (if any) they have in place to prevent chargebacks, and what kind of credit card processing fees they charge for disputes or chargeback incidents.
Reasons for Chargebacks
Chargebacks are both an operational and a financial issue for small business owners. In fact, according to a recent Midigator report, despite the decline in the percentage of revenue lost to chargebacks in recent years, businesses reviewed still lost 4.4% of revenue to chargebacks in 2019. Merchant revenue lost to chargebacks in 2017 equaled a substantial total of $19 billion.
With this in mind, it’s important to understand why customers initiate chargebacks—and what you can do to both prevent and dispute them. Here are some of the most common reasons that customers might file a chargeback:
- Legitimate fraud: In certain cases, chargebacks do serve their intended purpose—they give customers a quick and easy way to report fraudulent transactions on their credit card statement.
- “Friendly fraud”: A customer may file a chargeback for a number of other reasons—even though the charge is not technically fraudulent. These incidences have come to be known as “friendly fraud,” as they go against the founding principles behind chargebacks as a consumer protection mechanism. Here are some chargeback examples that could be categorized as friendly fraud:
- Avoiding the return process: For whatever reason, a customer may decide that they don’t want to go through the return process for a purchase and instead, they file a chargeback to try and receive a refund for the transaction. A customer may feel that the return process is too difficult, they don’t understand it, or the time limit indicated in the return policy has expired.
- Delivery issue: If there is a problem with delivering an order, for example, if the customer never received it, they may file a chargeback.
- Pricing issue: If the customer feels they are overcharged for their order, charged the wrong price, or charged twice, they might submit a chargeback with their credit card issuer.
- Unhappy with product or service: If a customer is unhappy with the product or service they received, they may file a chargeback instead of going through the merchant to remedy the situation. Similarly, a customer may submit a dispute if they receive a damaged or defective product. This chargeback example could also fall under “avoiding the return process.”
- Don’t recognize the transaction: In some cases, a customer may forget they made a transaction and file a dispute. If you run a subscription-based business and have recurring payments set up, a customer could potentially file a chargeback if they forget about their subscription or forgot to cancel it. Additionally, a customer may not recognize your business name on their statement and think that the charge is fraudulent.
How to Prevent Chargebacks
Whether caused by legitimate or friendly fraud, chargebacks are problematic for small businesses. Therefore, let’s review some of best tactics you can employ to prevent (or at least lessen) the number of chargebacks your business faces:
Follow credit card acceptance guidelines and best practices.
First and foremost, you can prevent chargebacks by following credit card guidelines, remaining PCI-compliant, and using all the tools available to you to prevent legitimate fraud.
For example, you’ll want to ensure that you use a reliable POS system or payment gateway, provide receipts to customers, and train your employees on the acceptable ways to process credit cards. You should ensure that all of your POS hardware is EMV compliant—and if you do have cards that are swiped, that you require signature or ID.
Similarly, if you’re processing debit cards, you’ll want to make sure that customers either enter their PIN number or sign a receipt in order to authorize the transaction. Additionally, if you accept credit cards online or over the phone, you’ll want to require that customers provide all the card details—including the expiration date, type of card, and CVV code.
Generally, your POS or payment gateway provider will include fraud prevention tools and technology as part of their service. Therefore, along with employing these standard best practices, you can also use these tools to prevent chargebacks.
Develop clear, visible business policies and focus on customer service.
Although following credit card acceptance policies will help prevent incidents of legitimate fraud, they may not be as effective at preventing chargebacks that result from friendly fraud. One of the best actions you can take to prevent these kinds of chargebacks is to develop clear and visible businesses policies—especially those that relate to shipping and returns.
Many friendly fraud chargebacks stem from customers who have an issue with their purchase but feel that it’s easier to dispute the charge with their credit card issuer instead of working with you, the merchant.
To prevent this, you want to make it as easy as possible for customers to return merchandise, understand the shipping timeline, and talk to you about any issues they have. For example:
- Provide tracking information for all orders.
- Use a reliable shipping service that shows proof of delivery.
- List your shipping timeline and policies (i.e. what customers can expect) clearly on your website, as well as include them with order confirmations and receipts.
- Display your return and refund policies clearly (whether at your store or on your website) and make the process as simple as possible for customers.
- Make your pricing clear and evident (including discounts) and itemize everything on receipts or confirmation so there’s no price confusion. If you have recurring payments set up for a subscription service, you can contact your customers before processing the payment to remind them of the charge.
- Ensure that your business name is recognizable on credit card statements.
- Encourage customers to reach out to you by phone, email, or live chat with issues—and respond to any customer complaints promptly. You can try to set reasonable expectations and do what you can to work with the customer to resolve any legitimate issues with your service or product.
Although it may be difficult to avoid every incidence or type of friendly fraud, by focusing on some of the most common causes, you can hope to prevent chargebacks before they happen.
Work with a top merchant service provider.
Finally, another way you can help prevent chargebacks at your business is to work with a top merchant service provider. When it comes down to it, your merchant service provider not only provides you with the tools you need to accept and process card-based payments, but they’ll also be the ones working with you through chargebacks when they do occur.
Therefore, you’ll want to compare different providers carefully and talk to them about how they handle chargebacks, what their fees look like, and what tools they have available to prevent both legitimate and friendly fraud.
Ideally, your merchant service provider should be able to help you through the dispute process and refute illegitimate chargebacks that your business faces.
This being said, if you’re a brick-and-mortar business looking for an all-in-one payment processor and POS provider, you might work with a company like Square, which has a very simple dispute process with no associated dispute fees.
If you’re instead looking for a more traditional merchant account provider (as opposed to a payment service provider) you might work with a reputable processor like Payline Data, Payment Depot, or Fattmerchant.
Use our guide to compare the best merchant service providers for small businesses.
How to Dispute Chargebacks
No matter how proactive you are, it’s very likely that your business will face chargebacks at some point—therefore, it’s important to understand what to do when this occurs.
If your business is notified of a chargeback, the first thing you’ll want to do is determine whether or not it’s legitimate. If, based on your investigation and records, the charge does seem suspicious—in other words, like it’s fraudulent, you’ll want to relay that to your merchant services provider.
In this case, they will work with the issuing bank to return the funds to the cardholder and hopefully, work with you to investigate further and take action to avoid future incidents of fraud.
On the other hand, if you think that a chargeback you receive is a case of friendly fraud, you’ll want to dispute the chargeback. In this case, one of the first things you can do is try to reach out to the customer to try and resolve the issue.
If you can come to some sort of agreement with the customer, you can then ask that they retract the chargeback with their credit card issuer. If you try to reach out to the customer, however, and they don’t respond or you can’t come to a reasonable agreement, you can work with your merchant service provider to offer evidence to fight the chargeback.
You might provide invoices or receipts, confirmation numbers, shipping details, any information or records that you have available to prove that the transaction is legitimate. Your merchant service provider will then offer that evidence to the issuing bank to use in their decision-making process.
Here are a few important tips to keep in mind:
- Stay organized. Ensure that you keep thorough and organized transaction records—as these can be essential to providing evidence to fight chargebacks.
- Communicate with your merchant service provider. Understand your merchant service provider’s process regarding chargebacks—after all, you can’t offer evidence to fight a chargeback that your provider hasn’t informed you about.
- Dispute cases of friendly fraud. Don’t be afraid to fight against transactions that you believe are legitimate. According to Mitigator’s chargeback report, 77.25% of analyzed disputes classified as fraud were actually friendly fraud. Additionally, in the same report, most merchants surveyed reported significant value in fighting chargebacks, with some participants reporting ROIs of over 100%.
Therefore, as a business owner, it’s important to understand how chargebacks work and the tactics you can employ to both prevent chargebacks and best serve your customers.
- Mercator Advisory Group. “Merchant Chargebacks Are on the Rise Due to Friendly Fraud”
- PayPal. “Resolving Disputes, Claims, and Chargebacks”
- Experian. “How Long Does a Credit Card Refund Take?”
- Midigator. “The Year in Chargebacks 2020”
- Verifi. “The Chargeback Triangle“