Merchants’ guide to the increasing world of chargebacks

The terms chargeback, reversal and payment dispute all refer to the same thing. It’s when a credit card company reimburses a buyer for a purchase, usually at the expense of the merchant, or vendor.

Chargebacks have long been more than a pesky problem for vendors due to the direct cost of these reversals, plus the cost of potential fees from credit card companies. Additionally, many vendors also bear the expense of either investing in payment systems with better fraud protection, or fighting chargeback initiations as they occur, which is very time consuming. Whatever the case, chargebacks are on the rise and they’re costing retailers billions each year, especially from fraud.

Globally, gross fraud losses reached $28.65 billion in 2019, up 2.9 percent from a year earlier. They’re expected to hit $32 billion in 2021, and $35 billion in 2025, according to Nilson Report, which tracks Card Fraud losses worldwide.

So, most chargebacks are initiated due to fraud, such as a purchase made without the knowledge or permission of the cardholder.

In other cases, the cardholder initiates a claim on a purchased item, sometimes legitimately, other times less so. That’s why this type of chargeback initiation is sometimes referred to as ‘friendly fraud,’ which is when a consumer is either aware of or complicit in a transaction but report it as unauthorized. These, as well as legitimate consumer claims, are growing, and seemingly at an increasing rate due to Covid-related supply-chain disruptions.

Over the past year, shipping delays have stressed consumers, many of whom were already strapped by income losses. Their reaction has been to file more disputes against their purchases – they’d rather have the money.

Of 500 US companies surveyed, 58 percent say they believe their chargeback rates have increased since March 2020. Of these, 45 percent chalk it up to delivery delays. That’s according to fraud-prevention firm Kount, a unit of Equifax Inc.

Herein is part of the problem. While chargebacks are designed primarily to protect consumers from fraud, which they do, they also transfer the cost burden of fraud primarily to merchants. In the US, the system grew out of the Fair Credit Billing Act of 1974, which created the chargeback to address consumer fears of lost or stolen cards.

Broadly speaking, this gave banks the power to refund a cardholder, void the transaction, and withdraw the funds that were deposited into the merchant account.

Regardless of who initiated a chargeback, there are five main participants in a chargeback, whether they are disputed or not:

1.      Cardholder – this is card owners and most often the initiator of a chargeback, especially in dealings with retailers and restaurants.  

2.      Merchant – the store or hospitality owner who bears nearly all the weight of chargebacks, disputed or not.

3.      Card issuer – the financial institution that issued the card and whose default setting in the chargeback process is to accept a cardholder’s claim.

4.      Acquirer – the financial institution responsible for collecting payment on merchants’ behalf

5.      Card Association – the card network such as Visa, Mastercard, Discover.

First thing here is to check accuracy of the reason code for the chargeback. The reason code is issued by the card issuer, alongside the chargeback itself. If the reason code says the product was not received, the merchant can check to see whether it ever shipped. If it hasn’t, best to accept the charge.

In contrast, if a customer claims falsely that a product never arrived, the merchant can show proof of shipment, and in most cases delivery. Time to fight.

In this case, a rigorous process begins of gathering and submitting evidence in an attempt to overturn the chargeback–all within a limited timeframe. This requires substantial documentation such as return policy, signed receipt, and much more.

Upon receipt, the card-issuing bank will make a final decision that awards either the merchant or the cardholder. Unfortunately, even when a chargeback is reversed, the merchant must still pay the chargeback fee, and the transaction will still count against the merchant's chargeback ratio, a kind of quality score.

Here are all the steps leading up:

- The process generally begins when a cardholder disputes a purchase to their card-issuing bank.

- The bank reviews the disputed transaction for merit, based on information taken from the cardholder (the bank’s customer).

- The bank responds yay or nay to the request, usually the former as the cardholder, not the merchant, is the bank’s customer.

- The bank issues a conditional refund to the cardholder, debits the merchants account (sometimes charging fees to the merchant) and issues a reason code for the chargeback.

- The acquirer accesses the refund request and sends the chargeback notice to the merchant, which the merchant will either, accept, dispute, or in some cases not notice.

In nearly all cases, merchants are liable for chargebacks and bear all burden of proof to overturn them. This is true regardless of the origin of the payment dispute, which could range from a stolen card, some other form of card fraud, a legitimate or illegitimate consumer claim or a merchant error, such as charging one item twice, or manually keying in the wrong card number.

Merchants can prevent many chargebacks by ensuring that customers understand what they are buying, maintaining clear purchase and return policies and providing careful and attentive customer service. When that’s not enough, it may be time to invest in a POS technology or service provider that offers better fraud detection, and/or claims reconciliation. 

Top-shelf financial technology vendors deliver increasingly smart and automated payment systems, from POS gear to software. Some also provide extensive consulting and best practices. Taken together, the right payment solution can help prevent and consulting service designed to fight chargebacks and disputes, prevent fraud and reclaim your upper hand in the battle.

Start by making sure your POS is EMV compliant—a requirement for merchants since 2015 to adopt the global payment technology standard established by Europay, Mastercard and Visa. Basically, it means your point-of-sale system accepts EMV chip-embedded cards). Non-compliance not only raises the risk of fraud, but seals the merchant’s responsibility to pay the full cost of fraud.

Beyond that, ensure accurate product descriptions on all merchandise, use damage-proof packaging as much as possible for shipped goods and make sure that all shipping instructions and names on bills are clear and accurate. Taken together these measures can bolster security and more than chip away at chargebacks.