What are Chargebacks?
A Guide to Chargebacks for Both Merchants and Consumers
Chargebacks are a subject that merchants, as well as online shoppers, often overlook. However, excessive chargebacks can easily sink a business if you are not careful. Understanding what are chargebacks and how to prevent them is just the first step in minimizing the damage which they can cause.
What is a Chargeback?
Chargebacks originated with the Fair Credit Billing Act of 1974 as a form of consumer protection. By working through their bank, a shopper may dispute a credit card transaction which they believe was fraudulent and have the charge overturned.
As they were originally envisioned, chargebacks are designed to instill consumer confidence in credit institutions. By offering chargebacks as a failsafe option, banks offer shoppers the confidence that they will always have some form of recourse to defend themselves from fraud.
When a consumer instigates a chargeback, they are going directly to the financial institution for a refund, rather than the merchant. The prospect of a chargeback is meant to ensure customer satisfaction and to discourage businesses from taking advantage of consumers.
What is Friendly Fraud?
Unfortunately, with the advent of online shopping, chargebacks have become a tool for fraud by which consumers can easily steal from merchants. There are numerous reasons why consumers might file fraudulent chargebacks including, but not limited to:
- The purchaser forgot about, or didn’t recognize, the purchase.
- The cardholder wanted to avoid fees or other penalties associated with returning the merchandise.
- The consumer experienced buyer’s remorse.
- The purchaser didn’t understand the merchant’s shipping policy.
- The cardholder deliberately committed fraud.
Fraudulent or otherwise unjustified bank chargebacks, known as “friendly fraud,” are a major source of loss for online retailers – at least $40 billion in 2013 was lost to friendly fraud.
What Chargebacks Mean for Merchants
When a consumer files a chargeback, the card issuer will evaluate the claim. If it is determined that the consumer might have a valid claim, the funds will be forcibly withdrawn from the merchant’s bank account and credited back to the cardholder’s.
A merchant against whom a chargeback is filed will then need to provide compelling evidence that the chargeback is not justified. For example, if the cardholder claims to have never received their purchase, the merchant will have to provide evidence that the item was indeed shipped.
If the merchant can provide evidence that the charges are not founded, the merchant’s bank (known as the acquirer) can dispute the chargeback on their behalf (a process called representment). Otherwise, the chargeback stands.
The mounting consequences of chargebacks can be disastrous for merchants:
- The merchant must pay a chargeback fee for each chargeback filed. Even if the cardholder cancels the claim or the merchant successfully overturns the chargeback, the fee will not be returned.
- As the consumer has no incentive to send the merchandise back after filing a chargeback, the merchant is unlikely to see their merchandise returned. The merchant loses the cost of the item, as well as potential profit from selling it in the future.
- Banks will levy huge fines against merchants for excessive chargebacks.
- Excessive chargebacks can lead to a merchant’s account being canceled, and the merchant being placed on the MATCH list.
- If placed on the MATCH list, merchants will be forced to go with high risk merchant accounts, along with the high processing fees which these account entail. Otherwise, the merchant will be unable to process credit card transactions at all.
- Even if a merchant wins a chargeback dispute, this will still negatively impact their chargeback-transaction ratio.
How Chargebacks Negatively Impact Consumers
Chargebacks pose serious risks for merchants’ long-term survival, but like a boomerang, chargebacks have repercussions for consumers as well.
While shoppers might assume it will be faster to initiate a chargeback rather than pursue a refund through the merchant, this is not the case. The cardholder might not see their money returned for several months while the merchant disputes their claim. In contrast, with a traditional refund, cardholders should see their money returned within a few days.
In addition, merchants are often forced to raise their prices in order to compensate for anticipated chargebacks, meaning that consumers face higher prices for the goods they want.
Those who use chargebacks as a tool to defraud retailers face consequences as well. For cases in which a chargeback is determined to be friendly fraud, the bank may close the cardholder’s account, negatively impacting their credit score. Alternately, the consumer may be forced to pay additional chargeback fees.
Protecting Yourself Against Chargebacks
There are several approaches merchants should take in order to fight unnecessary chargebacks:
- Providing attentive service and responding to customer inquiries in a timely manner
- Carrying quality, well-made products
- Providing clearly understood policies and transaction details to avoid confusing customers
- Fighting chargebacks – banks are less likely to file chargebacks against merchants who consistently dispute them
The negative effects of chargebacks can be most effectively minimized through merchants’ vigilance and attentiveness, as well as responsible behavior by cardholders.