How Do Chargebacks Affect Merchants?

Chargebacks are a common problem for merchants operating in the eCommerce space. And, this problem gets bigger with every passing year.

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Data from Mastercard suggests that global chargeback volume may reach $117.47 billion by 2023. Most of those losses will not be tied to the cost of the initial sale. Accounting for chargeback fees and other related revenue drains, the average chargeback will ultimately cost merchants $3.60 for every $1 in sales value. Why is this the case, though?

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Perhaps the main cause of these staggering figures is that the chargeback process is antiquated. It’s governed by rules that are often unevenly enforced.

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Chargebacks are the banking industry’s primary tool to recover revenue lost to fraud or abuse. As such, customers are more empowered than ever to bypass merchants altogether in pursuit of a refund…even when they may not be entitled to one.

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What are Chargebacks?

A chargeback happens when an issuing bank forcibly reverses a credit or debit card charge. When used properly, this payment reversal process serves as a valuable consumer protection mechanism.

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The two fundamental instances in which a cardholder is entitled to a chargeback include:

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Merchant Error: The risk of a forced payment reversal keeps merchants focused on providing exceptional service. It also deters fraudsters who might try to pose as legitimate merchants to sell sub-par or counterfeit products.

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Criminal Fraud: The ability to file chargebacks on fraudulent transactions keeps consumers safe from fraud while using payment cards. This helps ensure consumer confidence in payment card technology.

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The real causes of chargebacks, however, are slightly more nuanced than this might suggest.

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While chargebacks were intended to work as a consumer safeguard against unscrupulous merchants, the process has become rather one-sided. Since it is often more convenient for cardholders to dispute a purchase through their bank than to contact a merchant directly for a refund, chargeback misuse has become commonplace in the digital market.

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When Can Consumers Request a Chargeback?

There are specific circumstances when a consumer is entitled to a chargeback. For example, a cardholder can file a chargeback if:

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- Fraud or unauthorized charges occur on their account.

- An order was never delivered.

- Merchandise arrived damaged or defective.

- An item does not reflect what was purchased.

- The merchant charged the buyer multiple times.

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If a cardholder suspects fraud, they should contact their bank immediately to prevent additional losses from lost, stolen, or otherwise compromised payment cards. In almost all other cases, though, the cardholder must speak directly to the merchant before calling the bank. This is better for both parties.

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Many consumers often confuse chargebacks with refunds. However, a chargeback should only be reserved for instances in which the merchant couldn’t be reached for a refund, or they flatly refuse to provide a refund for a damaged or defective piece of merchandise. Working with the merchant can be a more collaborative process that will lead to a faster resolution.

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What if a cardholder wants to file a chargeback because a family member purchased something without permission? Or, maybe they didn’t like the item they bought, or are simply just trying to get something for free? Any of these scenarios would be cases of friendly fraud.

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According to the 2022 Chargeback Field Report, friendly fraud disputes are on the rise. Three-quarters of merchants consider friendly fraud either a “moderate” or “significant” concern.

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Costs & Consequences of Friendly Fraud

Regardless if a chargeback is due to a legitimate consumer concern or the result of friendly fraud, chargebacks feature both short and long-term ramifications for merchants:

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• 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 keeps the merchandise, the merchant loses that revenue and any potential future profit.

• If monthly chargeback rates exceed a predetermined chargeback threshold, fines totaling tens of thousands of dollars could be levied against the business.

• The acquiring bank may terminate the merchant's account if chargeback rates remain above the acceptable threshold.

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If a merchant’s account is terminated, they will be placed on the MATCH list. The MATCH list ensures that the business cannot secure a new merchant 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 merchant account at all.

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Merchants do have the right to dispute illegitimate chargebacks. Doing so isn't as easy as it sounds, though.

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Crafting an effective dispute takes significant resources. As a result, merchants rarely win DIY chargeback responses. According to the Chargeback Field Report, the average net recovery rate for chargebacks hovers around just 9 percent. In other words, the average merchant will recover revenue from fewer than one in ten chargebacks filed against them.

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Key Components of Chargeback Management

Keeping disputes and chargebacks to a minimum is much easier said than done, but it is possible. The right chargeback management strategy will save time, resources, and revenue. Chargeback management can also increase the longevity of one’s business and encourage better relationships with customers.

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The key steps to take in developing an effective chargeback management strategy or service include:

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Tracking KPIs

Transaction disputes are rife with case-related data. Analyzing and monitoring key performance indicators (KPIs) can help merchants identify trouble spots and fine-tune their management strategy.

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However, this information must be easily accessible and comparable. For example, one will need to be able to compare cases versus false declines, net win rate versus projected return on investment, and chargeback ratio across different card schemes. Customizable reporting with refinable KPIs must be an ongoing part of chargeback management.

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Related: eCommerce Metrics You Need to Start Tracking Right Away

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Learn Your Net Recovery Rate

One of the most important KPIs to track is net recovery rate. This figure is based on reversals as a share of total disputes filed; not just those to which the merchant responds.

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Many chargeback service providers prefer to advertise win rates based on reversals as a share of the number of chargebacks challenged. However, this can be misleading as secondary chargebacks may be filed at any time. Before hiring a third-party provider, one must be sure they calculate win rates based on disputes received, not just contested ones.

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Monitor Chargeback Ratios

Monitoring one’s chargeback-to-transaction ratio—known as a chargeback rate—can offer insight for fine-tuning and informed decisioning. It also serves another critical function.

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There are set thresholds for chargeback ratios. Breaching your chargeback threshold results in fines, higher processing costs, and even the loss of card processing rights. Remember that each card brand tracks chargeback issuances on their network, and establishes their own distinct chargeback thresholds.

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Invest in Chargeback Management Software

Chargeback management software is indispensable for keeping efforts organized. The right platform can facilitate and streamline functions, such as analyzing data, flagging potential fraud, and processing transaction errors. It can also increase accuracy and ensure response deadlines are met.

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Chargeback management software is a powerful and essential tool, but beware any provider who suggests that automated systems are all that’s needed.

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Create a Chargeback Prevention Policy

Concentrate on creating transparent, customer-centric policies that are intentionally written to discourage disputes.

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Merchant policies should clearly explain the conditions that warrant a chargeback, and outline situations where they are inappropriate. Policies should also clearly explain to readers where to turn to resolve potential disputes, directing cardholders toward the proper channels (rather than toward the bank).

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Preventing Chargebacks

For long-term change, merchants and consumers must be better educated about chargeback protocols and best practices. Both parties also need to accept responsibility for their actions in the process.

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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.

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In the meantime, effective chargeback management, combined with a complete internal fraud and error prevention strategy, can mitigate a hefty number of chargebacks. Over time, effective action can even prevent many disputes from happening in the first place.

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