Payment disputes are an inevitable consequence of a digital economy. As in-person, manual transactions are replaced by frictionless, card-not-present payments, the need to fairly arbitrate disputes between merchants and consumers is more important than ever.
Chargebacks are the primary tool banks use to resolve credit card payment disputes. When a consumer did not authorize a charge, or is unhappy with a product or service, they can challenge the charge with their issuing bank. If the bank feels the consumer’s claim is valid, they will initiate a chargeback in order to reverse the payment.
The chargeback process is antiquated and governed by rules that are often unevenly enforced. Both merchants and consumers can feel frustrated by the system.
In this article, we’ll explore how chargebacks work, where they came from, and how they have changed over time. We’ll also examine some of the consequences of chargeback misuse.
What Are Chargebacks?
A chargeback is a credit or debit card charge that is forcibly reversed by an issuing bank. This typically happens after a cardholder claims a transaction was the result of fraud or abuse.
Even the most reputable online businesses will struggle with chargebacks. For cardholders, chargebacks act as a shield against criminals or dishonest business practices. For merchants, however, chargebacks can pose a serious threat to revenue and business sustainability.
One study showed that payment disputes resulting from criminal activity cost merchants an estimated $20 billion in 2021. That’s an 18% increase over 2020.
Chargebacks can seem unfair to merchants. They are meant to act as a consumer safeguard. The process is naturally skewed towards the cardholder, providing protection from:
Difference Between a Chargeback and a Refund
To cardholders, chargebacks can seem just like traditional refunds. They’re not, though. That’s the problem.
With most refunds, the cardholder is obligated to return whatever was purchased to get their money back. That’s not the case with chargebacks, where the cardholder bypasses the merchant altogether and asks the bank to intervene.
When this happens, the merchant loses the revenue from the sale, and the value of the merchandise. They also lose the value of overhead costs like shipping, fulfillment, and interchange. Finally, the merchant is also forced to pay a fee for every chargeback.
Debit Card vs. Credit Card Chargebacks
Consumers tend to use credit and debit cards interchangeably. While there are a lot of similarities between the two, debit cards and credit cards each offer different levels of fraud protection.
In cases of credit card fraud, the cardholder’s liability is limited to no more than $50. Because the funds technically belong to the bank, not to the cardholder, the bank may be more invested in trying to recover the money.
In contrast, debit cards are tied to funds that actually exist in the cardholder’s account, rather than to a line of credit issued by the bank. Cardholder liability for debit card fraud is limited to no more than $500, assuming the cardholder reports the incident within 60 days. Otherwise, their right to recover funds is dependent on the bank’s judgement.
Where Did Chargebacks Come From?
In the early 1970s—before all the above protections had been put in place—bank credit cards had not yet gained widespread acceptance in the US.
Consumers were hesitant to use payment cards. To be fair, they had good reason to be skeptical. It wasn’t hard to steal these early cards and use them for unauthorized transactions. If that happened, the legitimate cardholder could get stuck covering those bogus charges.
There were also complaints of merchants taking advantage of consumers. Some dishonest merchants inflated prices or added extra charges to a bill after the fact. The Fair Credit Billing Act of 1974 was an attempt to address these issues by creating chargebacks as we know them today.
The chargeback option protected consumers in two ways. First, it strictly limited consumer liability in cases of fraud. At the same time, it gave them the right to fight back against unfair or deceptive merchant practices.
The federal mandate was designed to help relieve consumer fears. And, for the most part, it worked. Credit card use exploded throughout the US in the 1970s.
A half-century later, chargebacks are still an important consumer protection mechanism…at least, when they’re used as intended. Like we’ll see, however, that isn’t what’s happening.
How Do Chargebacks Work?
Let’s look closer at the chargeback process itself. From the merchant’s perspective, stemming the flow of chargebacks is challenging, at best. There are multiple players and a lot of moving parts. Even worse, transactions can be disputed weeks or months after the actual sale.
The number of steps involved in the chargeback process will vary based on a lot of different factors. That said, here’s a basic rundown of how it works:
Step 01 | Cardholder files a chargeback
The cardholder initiates a dispute by contacting the bank and asking for a refund.Learn more about reasons for cardholder disputes
Step 02 | The issuer reviews/assigns a reason code to the case
This code explains why the consumer is disputing the transaction.Learn more about chargeback reason codes
Step 03 | The issuer investigates the complaint
If the case is considered valid, funds will be removed from the merchant’s bank account and credited to the cardholder, who may see a provisional credit on their account. If the bank feels the case is unwarranted, the dispute will simply be voided.Learn more about provisional credits
Step 04 | The acquirer is notified and reviews the chargeback
Any evidence the acquirer has to counter the chargeback will be submitted on the merchant’s behalf. If no such evidence exists, the bank will pass the chargeback along to the merchant.Learn more about compelling evidence
Step 05 | The merchant receives and reviews the chargeback
If the claim is legitimate, the merchant must accept the loss. However, merchants who believe they can disprove the claim have the right to re-present the chargeback to the issuer.Learn more about representment
Step 06 | The issuer reviews evidence and makes a decision
If the merchant’s evidence refutes the cardholder’s claim, funds that were removed due to the chargeback will go back to the merchant. Any chargeback fees or administrative costs, however, will not be repaid to the merchant.Learn more about arbitration chargebacks
What if the merchant’s evidence doesn’t refute the cardholder’s claim? The transaction amount is permanently moved from the merchant to the cardholder, and the chargeback stands.
It may seem like merchants are basically being judged “guilty until proven innocent” here. In truth, that’s more or less the case.
Like we said before, though, chargebacks remain an important consumer protection mechanism. It’s just one that has been subverted in such a way that modern merchants are actually becoming the victims.
When Can Consumers Use Chargebacks?
Today, credit cards are such a ubiquitous part of life that many users don’t even realize they have chargeback protection. Those who know about chargebacks often fail to understand what is—and what isn’t—a valid credit card chargeback use case.
Of course, there are situations where cardholders have every right to file a chargeback:
Fraud or unauthorized charges on the account.
Orders that were never delivered.
Merchandise that arrives damaged or defective.
Orders that do not reflect what was purchased.
Incorrect charges (additional charges or incorrect totals).
For lost or stolen cards, cardholders should contact the bank immediately to prevent additional losses. In almost all other cases, though, the cardholder needs to talk directly to the merchant before calling the bank.
Most accidents or innocent mistakes can be rectified with a simple call to the merchant. This is better for both parties. The merchant avoids a chargeback, and the cardholder gets their money back much quicker than they would with a chargeback.
Of course, a chargeback may be in order if the merchant isn’t able—or willing—to work toward a mutually agreeable solution. It’s generally better for merchants if they cooperate, though.
When are Consumers Not Entitled to Chargebacks?
Chargebacks may have been designed as a form of consumer protection, but industry regulations have not kept pace with payments technology. This allowed chargebacks to become weapons which consumers can use against merchants.
The internet and eCommerce have made shopping more convenient than ever. But, at the same time, filing a chargeback is also easier than ever. The anonymity of online transactions makes it difficult to fully validate buyer’s claims.
Because of chargeback abuse, merchants are now more likely to experience fraud coming from customers than from criminals. Friendly fraud—also called chargeback fraud—refers to situations where customers dispute legitimate charges. This can happen innocently or maliciously. The negative impact on the merchant is essentially the same either way, though.
There are multiple ways a cardholder might file a chargeback inadvertently. For example, if the cardholder:
does not recognize—or simply forgot about—the purchase.
forgot about a recurring payment.
misunderstood the delivery date and believed they’d been scammed.
asked the bank about a transaction, unknowingly initiating a dispute.
believes a chargeback is the same as a refund.
believes filing a chargeback will be easier or more convenient.
That last one is highly relevant. Based on what consumers claim at the time of filing, nearly half of all chargebacks are blamed on “unauthorized transactions.” A survey conducted by Chargebacks911, however, found that 81% of cardholders filed a chargeback simply because they didn’t have time to request a refund from the merchant.
What About Deliberate Chargeback Fraud?
Friendly fraud is a serious problem. Keep in mind, however, that not all chargeback fraud is “friendly.”
Consumers deliberately abuse the chargeback process for a variety of reasons:
The cardholder wants to make a return but avoid a restocking or handling fee.
The cardholder experiences “buyer’s remorse.”
The cardholder finds the return process too slow or cumbersome.
The cardholder waited too long and the return time limit expired.
A family member made the charge but the cardholder doesn’t want to pay the bill.
The cardholder wants to get something for free.
Cardholders might think a single incident of chargeback fraud is no big deal. It adds up quickly, though. Chargebacks will cost merchants approximately $117 billion annually by 2023. In reality, the costs could be even higher when accounting for false positives, and other sources of lost revenue. The majority of these losses will be the result of friendly fraud and chargeback abuse.Learn more about chargeback costs
Chargeback Costs & Consequences: Merchants
Chargebacks have both short and long-term ramifications for merchants.
Each time a consumer files a chargeback, the merchant is hit with a fee ranging from $20 to $100 per transaction. Even if the chargeback is later canceled, the merchant will still have to pay fees and administrative costs.
If the consumer files a chargeback and simply keeps the merchandise, the merchant loses that revenue and any future potential profit.
If monthly chargeback rates exceed a predetermined chargeback threshold, excessive fines (in the ballpark of $10,000) will be levied against the business.
If chargeback rates remain above the acceptable threshold, the acquiring bank may simply terminate the merchant’s account.
If the merchant’s account is terminated, that business will be placed on the MATCH list. The business is blacklisted, and will be unable to secure a new bank account–even with a different service provider–for at least five years. Their only option will be to secure a high-risk merchant account… if they can get a bank account at all.
While merchants have the right to dispute illegitimate chargebacks, doing so is more difficult than it sounds. Crafting an effective dispute takes significant resources. Merchants rarely win DIY chargeback responses; according to our data, the average net recovery rate for chargebacks is just 12%.
Chargeback Costs & Consequences: Consumers
Merchants aren’t the only ones who will suffer due to illegitimate chargebacks and friendly fraud. In the end, consumers may pay a price as well:
A chargeback will typically take several months (traditional refunds usually take a few days).
If the bank discovers a chargeback is friendly fraud, the cardholder may be penalized, or their account may even be closed.
Cardholders who “cry wolf” too often may not get the help they need in cases of legitimate fraud.
A bank account closed due to chargeback abuse may negatively impact the cardholder’s credit score.
In order to compensate for chargeback fraud, merchants raise their prices, which hurts all consumers.
Who is Responsible for Chargebacks?
For long-term change, both merchants and consumers need to be educated on chargeback protocols and best practices. Both parties also need to accept responsibility for their actions in the process.
Cardholders must remember that credit card chargebacks should only be filed in extreme situations. Chargebacks are a last resort; they should never be the first action to take when seeking a refund.Learn more about partial chargebacks
Also, more than one party may be responsible for a dispute. When this happens, the bank may issue a partial chargeback, giving the cardholder their money back for the portion of the transaction to which they’re believed to be entitled.
For their part, merchants must work to reduce the risk of chargebacks, both legitimate and illegitimate. Seeing a drop in friendly fraud may simply require providing prompt, transparent, and attentive customer service.
The right prevention tools will help, too. Implementing fraud detection strategies will enable merchants to identify more fraud incidents before they happen.
Finally, fighting invalid chargebacks is a must for merchants. It helps educate consumers about the proper use of chargebacks. Plus, banks issue fewer claims against businesses who regularly contest illegitimate cases.
With proper education and action, merchants and consumers can see a decline in the number of fraudulent chargeback claims, both now and in the future.
The Bottom Line
eCommerce technology is constantly evolving, and new chargeback threats appear daily. An effective chargeback management strategy must be flexible enough to identify new trends and techniques, counteract new technology, and adapt on the fly to a shifting landscape.
No one understands this better than the experts at Wintranx . That’s why we offer the most comprehensive chargeback management services and products available. Our transparent, end-to-end solutions go beyond prevention to revenue recovery and future growth.
Whatever you need to fight chargebacks, we can help. Contact us today for a free demo.Consult now