A chargeback is a process that allows a credit card holder to dispute a transaction and request a refund from the bank that issued the original charge. Chargebacks are typically initiated when a customer believes that the transaction was fraudulent or unauthorized, or the goods and services were not provided or failed to meet their expectations.

When a legitimate credit card holder disputes a transaction on their credit card, instead of reaching out to the merchant, they claim their money back directly from the card issuer (such as Visa, Mastercard, and American Express). The issuer then recoups the chargeback amount from the retailer and assesses a fee for processing the dispute claim.

The chargeback process

In a chargeback, multiple key players are involved, such as the cardholder, the merchant, the acquiring bank, the issuing bank and the card network.

1. Merchant: A merchant is a business or individual that sells goods or services to customers.
2. Acquiring bank: A bank or financial institution that processes credit or debit card payments on behalf of a merchant. The acquiring bank passes the merchant’s transactions along to the applicable issuing banks to receive payment.
3. Issuing bank: A bank or financial institution that offers payment cards to consumers on behalf of the card associations or networks.
4. Card network: An organization owned by financial institutions that licenses bank credit card programs of a specific brand, such as Visa, MasterCard or American Express.

Types and causes of chargebacks

There are generally three types of chargebacks: fraudulent chargebacks, merchant error chargebacks, and friendly fraud chargebacks.

1. Fraudulent chargebacks: The common causes of a fraudulent chargeback are stolen card details or account takeover (ATO) fraud, where fraudsters gain access to an individual’s account and make unauthorized purchases.
2. Merchant error chargebacks: These result from errors by the merchant, such as incorrect billing or failure to deliver goods. Examples include ‘item not received’ (INR) when the customer claims that they never received the item or that the item is ‘significantly not as described’ (SNAD), when the item received differs significantly from what was described in the product description.
3. Friendly fraud chargebacks: These happen when a cardholder disputes a legitimate transaction, either intentionally or due to forgetfulness. Commonly known as ‘liar buyer’ or ‘friendly fraud’, these chargebacks occur when a cardholder claims unauthorized card usage or stolen financial information was responsible for a transaction under false pretenses.
   

What is a chargeback dispute?

A chargeback dispute is a process where merchants challenge illegitimate chargeback claims.

Intended as a consumer protection tool, a chargeback occurs when the cardholder notifies their card issuer that a transaction was unauthorized or otherwise problematic and requests a refund.

In some cases, individuals may fail to recognize an authorized transaction, which generally occurs when a credit card is stolen or fraudsters gain illegitimate access to users’ accounts and make unauthorized purchases.

Another common reason for a chargeback is when a customer attempts to take advantage of the process to get a refund despite having authorized the initial transaction and received the goods. Friendly fraud is on the rise: per Riskified findings, it has increased by 63% in recent years.

During and beyond COVID, ecommerce sales have surged, but so have chargebacks. In fact, in the last year alone, more than three out of four customers filed a chargeback — an all-time high. Chargebacks now represent a standard part of consumer online shopping behavior and a significant part of ecommerce business management.

Merchants need to be prepared to prevent the staggering increase in chargebacks. If merchants believe a chargeback claim is unjust, they can fight it with a chargeback dispute or a chargeback representment. However, to combat a chargeback, merchants must provide compelling evidence that the purchase was authorized. Handling disputes is crucial, as excessive chargebacks can lead to high fees and enrollment in excessive chargeback programs.

Steps of a chargeback dispute

Step 1: Cardholder files a chargeback.

Step 2: The issuing bank reviews the claim and if it’s determined to be valid, it will be sent to the acquiring bank.

Step 3: The acquirer reviews the chargeback. If they deem it invalid, they will decline it and inform the issuing bank. If they deem it to be valid, they will inform the merchant.

Step 4: The merchant reviews the chargeback and either accepts the chargeback or files a dispute supported with compelling evidence.

Step 5: If the evidence is deemed compelling, the issuing bank rejects the claim and the customer is charged. If the evidence is not compelling, then the credit will be taken from the acquiring bank. Representment or chargeback disputes occur during step four when the merchant needs to support their dispute with compelling evidence.

How do chargebacks affect merchants?

The cost of chargebacks can be substantial for merchants. Beyond direct revenue loss, chargebacks involve additional fees and can flag a merchant as high-risk by the credit card network, making future credit card payment acceptance more difficult and expensive.

The consequences of chargeback may include:

• Revenue loss: Merchants lose 100% of the profit on undisputed chargebacks, including the value of merchandise, processing, and shipping fees. They need to repay the full amount for each chargeback, immediately cutting into their profit.
• Financial penalties: Exceeding monthly chargeback thresholds can lead to placement in excessive chargeback programs by credit card networks, resulting in hefty fines. These fines are distinct from the original transaction’s loss; they are additional fees for processing the customer’s claim. If the chargeback rate increases, these fines can quickly accumulate and add a substantial cost to a merchant’s operations.
• Higher processing costs: Merchants may be forced to obtain high-risk merchant accounts with increased processing fees. For example, American Express may require merchants with high inquiry rates to accept full liability on all inquiries.
• Account termination: In rare cases, merchants’ accounts may be terminated by credit card networks due to high chargeback rates. This consequence effectively blocks the merchant’s ability to accept future credit card payments through that network, posing a threat to businesses heavily reliant on card transactions. Such terminations are typically a last resort, but highlight the critical importance of managing chargeback rates.
• Reputational damage: A high chargeback rate can damage a merchant’s reputation with consumers. A Riskified survey shows that almost 50% of consumers would not shop again at a merchant after experiencing a fraud incident related to that business. This erosion of consumer trust directly translates into lost future sales and a tarnished brand image, making it harder to attract and retain customers.
• Operational burden: Disputing chargebacks is resource-heavy and labor-intensive, often requiring significant manual work and time. Merchants must dedicate resources to gather evidence, respond to inquiries, and manage communication with banks and customers. These efforts add an indirect cost, affecting efficiency and delaying chargeback dispute processes.
• Profit erosion: The cumulative effect of all chargeback-related costs — including direct revenue loss, financial penalties, higher processing fees, and the operational burden of disputes — leads to ongoing erosion of merchant profits. This impact signifies that chargebacks do not just represent isolated losses but rather a continuous drain on a business’s financial health. Furthermore, a concern like “double refund chargebacks,” where a customer files a chargeback and simultaneously requests a refund from the merchant, can inadvertently lead to refunding the same item twice, directly compounding profit erosion.

Merchants need to understand the impact of chargebacks to manage the effects and protect their business. This understanding enables them to implement robust prevention and chargeback management strategies.

Chargeback management strategies

Most merchants currently use a combination of in-house, third-party, or hybrid approaches to chargeback management.

Regardless of what approach merchants take or plan to take, chargeback managers typically have significant room for improvement to recover more revenue and increase efficiency, accuracy, and measurement.

Strategies to implement for better chargeback management

• Increased automation: Applying automation to some or all of the chargeback management process increases efficiency. Lower-value or straightforward chargebacks can be automated, while complex or high-value cases can be reviewed manually by experts. Automation frees teams to focus on strategic disputes and tackle previously uncontested cases.
• Simple, centralized access: Centralizing chargeback sources into one platform simplifies management, prevents chargebacks and evidence from falling through the cracks, and stores all historical data, documents, and evidence in one place.
• Better labeling and evidence management: Improving the ability to capture, label, and analyze evidence data can help merchants dispute chargebacks more effectively.
• Improved up-front prevention strategies: Increasing involvement in upfront chargeback prevention by identifying specific chargeback drivers (such as product lines, regions, or service types) and concentrating efforts on understanding the root cause of chargebacks can significantly aid in their management.

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How your business can prevent chargebacks

The nature of chargeback fraud coming from legitimate customers makes it tough to prevent. Merchants may find it hard to know what or when to dispute a chargeback. In many cases, merchants don’t want to deal with the rigorous chargeback dispute process, so they let many illegitimate chargebacks slide by. However, not disputing fraudulent chargebacks makes it easy for repeat offenders to target the business.

Most merchants lack the time, resources, or expertise to conduct in-house dispute resolution. As such, many rely instead on technology to make data-based decisions to automate their chargeback disputes.

Proactive measures, such as clear billing descriptors and delivery confirmations, help reduce chargebacks. When prevention fails, representment allows merchants to dispute unjust claims. Effective chargeback management not only retains revenue but also sustains business success and reputation.

Chargeback management strategies are essential for merchants to efficiently handle disputes and minimize revenue loss. Some effective approaches to prevent chargebacks include:

• Leverage data and reporting: Improve data management and reporting to better understand chargeback patterns and feed insights back into prevention strategies.
• Educate and train teams: Utilize education and training resources to keep teams informed and equipped to prevent chargebacks effectively.
• Stop fraud early: Implement fraud detection and interception strategies such as suspending accounts or contacting shippers to stop fraudulent transactions before chargebacks occur.

Chargeback dispute: what, when, why, and how?