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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Multilateral Interchange Fee Caps will have a Mixed Effect in Europe

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Earlier this year, the European Parliament voted to regulate credit and debit card interchange fees, lowering the cap to 0.3% and 0.2% respectively. Coming into effect in January 2015, the multilateral interchange fee (MIF) regulation is designed to enforce a fair price among all products and providers in order to encourage new market-entrants and increase competition within the Single Euro Payments Area (SEPA).

MIFs are the fees paid by merchants to payment card providers in exchange for the ability to accept credit and debit card payments both online (card-not-present or CNP transactions) and at the point-of-sale (POS). There has been some resistance to the regulation, particularly from card providers who collect the profits from MIFs, but also from merchants and SEPA-opponents in specific parts of Europe which could potentially see negative effects as a result of the regulations.

SEPA and MIFs

 The Single Euro Payments Area is a payment integration initiative coordinated by the European Payment Council in order to introduce a single, harmonised payment format for all transactions in the euro currency. The initiative was designed to integrate the separate national European markets into a single domestic market.

Following in SEPA’s footsteps, the new MIF regulation eliminates the difference between cross-border and national card payments, treating all European card payments equally. While our previous article about SEPA mostly focused on the benefits of that initiative, now that the deadline has passed there is going to be a long period of growing pains while the formerly fragmented European markets merge their payment systems.

Added to these growing pains are further initiatives spearheaded by the European Commission, including the interchange fee cap. This and other initiatives are designed to be beneficial to the European payments landscape overall, but because they apply without prejudice to all eurozone countries, some countries will initially benefit more than others due to existing payment habits, technological infrastructure and economic realities.

UntitledFor example, in the UK the introduction of additional layers of security to card-not-present (CNP) transactions such as Visa 3D Secure and MasterCard SecureCode has had a positive impact on conversion rates. Despite the additional step in the purchase process, customers in the UK are more likely to make a purchase if they have the additional assurance of security. Meanwhile in Germany, the very same technologies have had a significant negative effect on conversion rates.

These extra layers of security are being enforced by the MIF regulation and will therefore now be required by all payment card-accepting merchants. Because of this, merchants who do not already offer the required extra layer of security, particularly those in markets where these technologies have had a negative effect on conversion rates, will initially be at a disadvantage once the regulation comes into force.

However, in the long-term, the regulation will force merchants to increase their level of security and ultimately allow them to profit from the lower interchange fees, which are likely to be shared with consumers in the form of lower prices.

In addition, the mixed effects that the regulation will have in different regions of Europe only applies to card-not-present transactions, while the effects on point-of-sale transactions will almost universally benefit merchants within the eurozone. This is because POS transactions in Europe are already compliant with the security requirements enforced by the new regulation and there is no additional investment necessary on the merchant’s side.

The Benefits

For consumers:

  • Secure and low-cost electronic payments widely available across the eurozone.
  • Wider acceptance of payments cards as more small merchants can afford the fees.
  • No hidden or unexpected fees from card providers.

For merchants:

  • The ability to accept payment cards at fair prices.
  • Cost savings which can be used to improve services and be passed on to customers.
  • Eurozone-wide products and services at a standardised cost.

For payment providers:

  • New market entrants and increased adoption of payment card services will grow total transaction numbers.
  • Increased e-commerce traffic mean increased opportunities for market additional services.
  • New and innovative payment products and technologies will be developed.

Proponents of the MIF regulation view it as a necessary component in establishing a true single euro payments area and in preparing the European payments industry for an increasingly digital marketplace. The European Commission has concluded that current interchange fee levels are anti-competitive, in that they discourage new market entrants and cost businesses an average of 9 billion euro per year. Much of those costs are then passed on to the consumer in the form of higher prices.

In regards to that, lower MIFs are expected to promote innovations, improve customer service and ensure flexibility. The costs savings to merchants are expected to increase competition and result in lower prices for their customers. The negative side-effects involved in establishing SEPA and its associated regulations, while not insignificant, are merely growing pains in the process of building a strong, modern European economy.