Chargebacks 101: The Real Costs You Need to Know About

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Being able to accept credit cards, though not an absolutely necessity, is a very important aspect of running an e-commerce business. In most European countries, credit cards are still the most popular online payment method, with studies having shown that offering multiple payment methods, including credit cards, directly affect your conversion rate. Despite all of the positive aspects to offering the option for your customers to pay by credit card, there remains a significant obstacle that online merchants need to be aware of: chargebacks.

Chargebacks are a form of consumer protection provided by issuing banks. They occur when banks forcibly reverse a transaction, returning funds to a consumer after they have disputed the legitimacy of a payment appearing on their credit card statement. The associated fees charged to merchants can be as much as 100 USD per chargeback, which is a costly burden to bear for entrepreneurs and small-to-medium sized enterprises or SMEs.

Chargeback Lag

Some of the key challenges associated with chargebacks arise from chargeback lag, the time between the date of the transaction and when the merchant is notified of the dispute. Although most chargebacks are initiated close to the original date of transaction (60 to 90 days), cardholders are legally permitted to file a dispute up to two years after a transaction, making lag time extreme and unpredictable.

Due to the delay in reporting, SMEs don’t have a clear picture of their financial health. The lag distorts true company performance and the losses incurred are only felt months later, limiting the merchant’s ability to respond to the cause of a chargeback in real-time and to adjust their business strategy accordingly.

Fraud

Chargebacks are often associated with fraud, and for good reason, as 58% of chargebacks are due to fraud. Online fraud is responsible for 100 billion USD in losses per year, and most of that is caused by chargebacks. The process begins when a cardholder files a dispute with their issuing bank regarding a specific “erroneous” transaction. Most of the time, the bank reaches the conclusion that the transaction was fraudulent and reverses it, returning the funds from the merchant to the cardholder and fining the merchant the associated fee.

Though fraud is the most common reason for a chargeback, there are a few other possibilities:

  • Technical: Due to a bank processing error, non-sufficient funds or an expired authentication, the transaction was not properly completed.
  • Clerical: The cardholder was erroneously billed in duplicate, was billed the incorrect amount, or was mistakenly never issued a refund.
  • Quality: The cardholder claims the product purchased was never received as promised.

The fines associated with chargebacks can cost a small merchant thousands of dollars per month alone. Because online credit card sales are card-not-present (CNP) transactions, they’re considered more risky than card-present transactions like those at the point of sale. As a result, merchants are often held 100% liable for any online fraud that may occur.

The effect that chargebacks have on a business is actually much worse than just the cost of fines. On top of the fines, merchants are also losing the revenue from the original transaction, the money invested in making the sale, the price of merchandise and the shipping costs involved in getting the product to the customer.

If shouldering these expenses weren’t bad enough, chargeback lag means that merchants need to absorb the losses long after the transactions were made — for instance, the amount of revenue earned in January can’t be accurately counted until April once a chargeback has been reported. This also means that a merchant is unable to respond to the cause of chargeback until 2 to 3 months later. In the case of fraud, this makes it very difficult to identify the vulnerability that enabled the fraud to occur.

Chargeback lag means that merchants have to spend months dealing with the fallout from chargebacks, distorting their financials and creating long-tail losses. This is a key reason why fighting fraud is an integral part of running an e-commerce business.

Preventing Chargebacks

Preventing chargebacks is a significant component of fighting fraud. The first step to preventing chargebacks is to anticipate them, by being aware of the following warning signs that your company may be being targeted by fraudsters:

  • Chargeback rate higher than 0.5%
  • Decline rate higher than 1%
  • Refund rate higher than 1%
  • High affiliate turnover
  • High shopping cart abandonment

These are all signs that cybercriminals may be attempting to perform fraudulent transactions at your web store. Keep a close eye on that chargeback rate – if it reaches 1%, you could be facing more fines and jeopardise your ability to accept credit card payments.

Friendly Fraud

Unfortunately, even the best anti-fraud technologies and practices won’t protect you from friendly fraud, which accounts for 41% of all chargeback fraud. Friendly fraud occurs when the cardholder knowingly performed the transaction, it was processed successfully, and the product was delivered as promised, and yet they filed a chargeback dispute nonetheless.

There are a number of reasons this could happen. Perhaps the customer was confused by the transaction description or legitimately couldn’t recall making the transaction. Unfortunately, in most cases, friendly fraud is a deliberately dishonest tactic for consumers to receive goods without paying for them; in other words, it is theft.

There is little merchants can do about this and the cardholders often succeed in this fraudulent tactic. While merchants can dispute chargebacks, it is a difficult and lengthy process and only 21% of chargebacks globally are decided in favour of the merchant.

Achieving a Balance

Chargebacks are a reality in e-commerce. While you will never reduce your chargeback rate to 0%, you can reach a balance between chargebacks and sales. Many anti-fraud techniques and know-your-customer policies do reduce chargebacks but can also create friction in a customer’s path to purchase that lowers your conversion rate and, ultimately, your revenue.

The key is to reduce your chargeback rate to a point that maximises your sales while keeping your losses to a minimum. Especially for entrepreneurs and SMEs running on slim profit margins, the importance of controlling your chargeback rate cannot be understated. Follow these tips to reduce your chargeback rate:

  • Ensure that your business name as it appears on your customers’ credit card statements matches your advertised business name and is clearly recognisable.
  • If you’re selling physical goods, make sure that the customer’s shipping address matches the billing address of the card they’re using to ensure that the card is not stolen.
  • Enforce additional customer verification procedures such as Verified by Visa and MasterCard SecureCode.
  • Automatically flag unusually large transactions for manual review before completing the transaction.

These are just a few ways to control fraud and reduce chargebacks. More tips on the subject can be found in these other helpful articles from the DalPay Blog:

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