The Merchant's Complete Guide On Everything You Need To Know About The Chargeback Process
PeerDive
For any business, chargebacks can present a logistical nightmare. Although chargebacks are an important protection that increases consumer buying confidence, especially with online transactions, they can be a huge headache for merchants. Unfortunately, with the increase of customers putting in a chargeback dispute, businesses are at a greater risk of customers going directly to the bank instead of working it out with the merchant first.
Across all industries, the average chargeback ratio is 0.60%. That means that six out of every 1,000 transactions will lead to a chargeback. Retail and travel industries tend to have a slightly lower chargeback ratio of 0.50%. Those in the financial service and education/training industries tend to have the highest ratio at over 1%. Why is that the case? Usually, since those businesses tend to have an intangible service rather than a physical product, they risk a higher chargeback ratio.
As a business owner, it is important to understand how the chargeback process works and what you can do to help protect yourself against receiving a fraudulent chargeback. At PeerDive, our experts have put together this comprehensive guide on everything you need to know about the chargeback process as a business owner.
The Definition of A Chargeback?
A chargeback is also referred to as a reversal. It is the return of funds, usually on a credit card, to make a purchase from the end buyer for a specific transaction. A chargeback can occur for a wide variety of reasons. This includes if a customer enters into a dispute claiming that the transactions were purchased or made without prior knowledge.
For cardholders, the option to file a chargeback can protect their purchasing power from dishonest businesses, scammers, and fraud. However, for merchants, chargebacks can seriously threaten their cash flow.
What Is The Difference Between A Chargeback and a Refund
Although a chargeback and a refund might sound the same to a customer, they are very different. Here are the main differences between the two:
Refund: As a business, you would be the one processing the refund transaction. You might initiate a refund giving the customer back their money if a customer is dissatisfied with your products or services.
In a refund situation, the customer would only be dealing directly with you as a business instead of a 3rd party. Usually, refunds are processed immediately back to the original method of payment instead of a waiting period.
Chargeback: Unlike a refund, a chargeback is when a merchant bypasses the business and goes directly to the processor to get their funds back from their purchase. The bank is the one that will facilitate the process on the customer's behalf.
With a chargeback, the bank will collect the disputed funds and hold them in a "limbo" account until a decision has been made. In other words, the bank has complete control over the funds and the end decision. Unlike a refund, the customer will not receive the funds right away. There is typically a waiting period until the bank makes the final decision.
*Note: A chargeback is not the same as a voided transaction. A voided charge is where a transaction is canceled before the purchase posts to the customer's debit or credit card. So, for example, if you accidentally charge the customer twice for the same item, you can void the transaction, saving the business the trouble of having a refund.
Chargeback Process Explained
Chargebacks for credit cards were first implemented into law in the 1974 Fair Credit Billing Act. Chargebacks laws were implemented as a direct response to widespread abuse by fraudsters that can use stolen information while the cardholder could do nothing about it.
A chargeback starts with the customer calling their bank to dispute a specific charge on their account. Once a chargeback has been initiated, it begins the back and forth between the bank and the merchant until the case has been resolved.
The number of steps will vary depending on the bank. That being said, here is a simplified process on how chargebacks work:
1) Cardholder Files a Chargeback
The cardholder will directly contact their bank, reporting a specific transaction(s) they wish to dispute. When a customer calls into dispute a transaction, the bank will first need to decide if the customer has the means to file the chargeback.
2) A Issuing Code Is Assigned
If the bank decides that the cardholder has the means to file the chargeback, the reviewer will assign an issuing code to why the customer is disputing the transaction. For example, this could be "Issuer did not receive goods or services as promised."
3) Merchant Is Notified
Once an issuing code has been assigned to the chargeback case, the merchant bank (aka the acquiring bank) will be notified by the customer's bank. Shortly after, the funds will be debited from the merchant's account and held in an escrow account until a resolution is reached.
4) Submission Of Evidence
As a merchant, you can either accept the chargeback or fight it back by submitting compelling evidence as to why the chargeback is invalid. Your submission might include invoices, communication back and forth with the customer, photos, and more. This process is called representation.
*Note: It is important to understand the reasoning code of why the customer is filing the dispute. For example, if the reasoning code is "customer did not receive the goods/services," your case should include evidence of whether you delivered the end good or service to the client.
5) Issuer Review of Evidence
If the merchant decides to fight the chargeback and submit evidence as to why the chargeback is not valid, the issuing bank will review the evidence and make a final decision. If the issuing bank decides in the merchant's favor, the funds will be returned in full back to the merchant. If the back decides in favor of the customer, the funds will be permanently withdrawn from the escrow account and returned to the client.
6) Pre-Arbitration
If either party is unhappy with the decision, they can initiate the pre-arbitration stage. This most likely will be happy if the merchant loses the case and there is new evidence that puts the final decision in question.
It is important to remover that each bank is different and will have its own set of rules. Therefore, speaking directly with your merchant processor is best if you want clarity on these rules.
7) Arbitration
During arbitration, the card issuer will examine the new evidence brought forth during the pre-arbitration stage to make a final decision. Once this decision is made, it can not be further appealed. In addition to having the funds removed from their account, the losing party will be required to pay a fine. This fine can range anywhere from $500+, depending on the bank.
How Long Does The Chargeback Process Take
Depending on the reasoning code the issuing bank assigned, the process can take anywhere from 15-90 days once all of the evidence is received.
When a merchant receives a chargeback notification, there is a time limit to when the merchant can respond. The countdown starts when the chargeback is initiated, not when the merchant is notified. Best to gather the evidence and submit your rebuttal as quickly as possible to avoid missing the deadline.
How To Avoid Chargebacks
Avoid the headaches that come from fighting a credit card dispute. At PeerDive, we work to help prevent the likelihood of a false chargeback against your business. We created this platform to learn more about their customers before they do business with them. Users can search Peer Dive and read real reviews from other business owners who interacted with a potential client. You can find out if this particular client has a history of putting false chargebacks on a business.
Our mission is to make it a little easier for businesses to work in a fair environment where reviews are not just one-sided as they are mainly portrayed on popular review sites such as Yelp and Google Reviews. With Peer Dive, you can learn all you need to know about a client before doing business with them.
Chargeback Fees
In addition to having the funds removed from your account, the merchant will be charged a chargeback fee. Depending on the bank, these fees typically range from $10-$200. For example, PayPal charges a $20 fee, and Stripe charges a $15 fee per chargeback case. Typically higher fees are associated with more traditional banks/merchant accounts, historically known for charging hidden fees.
The more chargebacks you get, the higher the fee could end up being. In addition, if you have too many chargebacks in a short time, your merchant account could get flagged, making you unable to process future credit card payments.
To avoid a chargeback and these additional fees, it is important to investigate the root cause. Is my system secure? Am I doing all of the necessary security checks? You might have holes in your system, leaving your business open to the potential of receiving a high number of chargebacks.
Common Reasons For Chargebacks
In 2019, a survey found that businesses lost an average of 4.4% of their revenue due to chargebacks. This equated to over 19 billion dollars lost per year. To help prevent a chargeback, it is important to remember why a customer could initiate a chargeback. Here are some of the most common reasons a customer might be disputing a transaction:
Transaction Is Not Recognized
A customer might forget that they made the transaction. This is especially true if you run a subscription-based business where recurring payments are set up. A customer could file a chargeback if they forgot to cancel their subscription. In addition, if your business appears as a different name on their credit card statement, they might not associate the transaction with your business and think it is fraud.
Unhappy With The Product/Service
Instead of going directly to the merchant, customers might file a chargeback if they are unhappy with the product/service they received. Similarly, if a customer receives a broken or defective product, they might submit a chargeback instead of wanting to complete the return process.
Delivery Issues
If there is a problem with the customer's delivery, they may file a chargeback. An example could be that the package was delivered to the wrong address by the carrier or the item came broken when it arrived.
Pricing Discrepancy
If the customer feels like they got overcharged for the order and/or got charged twice for the same order on accident, they might submit a chargeback with their bank.
Legitimate Fraud
In certain circumstances, a chargeback is valid on the client's end. This would include if the customer's credit card was stolen and used to make a fraudulent purchase. This chargeback type is the hardest to fight with an issuing back since it was someone else besides the client making that purchase. Always ensure you have the proper security measures to avoid this type of chargeback.
Avoiding The Return Process
Customers might decide they do not want to hassle with the return process. Instead, they will go directly to their issuing bank to get their money back. A customer might feel like the return process is too difficult or takes too long to complete, not knowing what happens on the backend of a chargeback case.
How To Prevent A Chargeback
No matter how proactive you are, at some point, your business will experience a chargeback case. The first thing you want to do when receiving a chargeback notification is to call your merchant processor to determine the reason the client initiated the chargeback. If it is a case of legitimate fraud, you might decide that you do not wish to pursue the chargeback. On the other hand, if the case falls under the friendly fraud category, you might wish to fight it.
Midigator's chargeback report states that over 77.25% of all chargeback cases were reported as friendly fraud. In the same report, merchants reported value in fighting chargebacks, with some participants reporting an ROI of 100%.
To prevent a chargeback from occurring, you can help protect your business by following the credit card guidelines and remaining PCI-compliment. You should also ensure that all of your POS hardware is EMV compliant.
If your business also processes debit cards, you want to ensure that every customer either enters a PIN number or signs a receipt to authorize the transaction.
Make sure you have a clear written return and exchange policy on your website and all receipts. If possible, try and get pictures or a signature from the customer.
Generally, your merchant processes will include fraud prevention tools as part of their services. Along with the proper employee training, you can use these tools to help your business better prevent a chargeback.
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