If you’re ready to take your home-based business to the online marketplace, you must first familiarize yourself with the consumer protection mechanism known as a chargeback.
It’s essential to understand both the causes and ways to fight chargebacks, as well as the long-term implications for your business’s longevity.
What is a Chargeback?
A chargeback is a forced refund for a credit or debit card purchase initiated by the cardholder’s bank. When a customer contacts the issuing bank to dispute a transaction, the bank can file a chargeback on the customer’s behalf and overturn the original sale.
The Evolution of Chargebacks: A New Threat
Chargebacks were originally introduced in the 1970s as a form of consumer protection. They were intended to reduce the cardholder’s liability when victimized by a criminal’s unauthorized transaction or unscrupulous merchant activity.
Decreasing cardholder liability increased confidence in payment card usage and later eCommerce.
However, this ‘zero liability’ policy has created a new challenge for business owners. With the invention of the internet—and subsequently eCommerce—cardholders have learned how to exploit loopholes in the chargeback process. They are now able to file illegitimate chargebacks and essentially engage in cyber shoplifting.
Many merchants assume chargebacks are simply a cost of doing business—nothing can be done to mitigate risk or maintain revenue. Fortunately, this is a myth, but it is a very dangerous assumption to believe.
Not only do chargebacks steal revenue (to the tune of more than $40 billion annually), they can also threaten the longevity of your business.
Your acquirer, or the bank that provides your merchant account, is a business just like any other. Acquirers are interested in keeping risk and liability low. So if your inability to successfully manage chargebacks is perceived as a risk, your payment processing capabilities could simply be revoked.
The internet has brought new earning potential for businesses, but also increased risk. Merchants must recognize this risk and take the necessary precautions or suffer the consequences.
The Three Sources of Chargebacks
In the pre-internet era, there were only two sources of chargebacks. Chargebacks were either filed because of criminal fraud or merchant error. Now, consumers themselves are becoming the fraudsters and have introduced a third instigator of chargebacks: friendly fraud.
Effective chargeback management depends on identifying the chargeback source and creating a strategy to address each threat.
Mitigating Merchant Error
Merchants are often distressed to realize their own inefficiencies, mistakes and oversights are actually a leading cause of chargebacks. The good news is, these chargebacks are almost entirely preventable.
Merchant errors can be anything from charging a card twice to not providing a refund to failing to deliver the merchandise on time.
These seemingly minor issues are usually easy to fix, but the merchant might not be able to identify these mistakes for what they are. An inability to remain objective or a misunderstanding of consumer preferences can mean chargebacks remain unchecked. Therefore, it is often advisable to receive outside counsel when evaluating policies and operations.
Fortunately, there are certain business best practices that can help reduce merchant error chargebacks.
- Write descriptive, yet easy-to-understand, policies and terms. Share this information with customers before completing the checkout process. Also, remind customers of what they’ve agreed to with the order confirmation email and the delivery receipt.
- Simplify your return process. Adopt a no-strings-attached cancellation policy. Less friction means fewer chargebacks.
- Provide live customer service for as many hours a day as possible (ideally 24/7). Use as many communication outlets as possible, including chat, social media, email and phone.
- Send an auto-responder to all email inquiries informing customers when they can expect a personal response. Monitor social media channels, and quickly address any customer concerns with courtesy.
- Ask for feedback, and take consumer preferences into consideration.
- Educate customers about the shipping process. Let them know when orders will be shipped and when they should arrive. If possible, consider free or expedited shipping.
- Clearly set customer expectations regarding merchandise quality. Write accurate product descriptions that include images.
- Follow all payment processing guidelines set forth by card networks and your acquiring bank.
Mitigating Criminal Fraud
Credit card fraud is a major threat to both cardholders and merchants a like. Criminals are extremely adept at profiting from stolen payment card information. However, while the threat is still very real, it is much easier to manage criminal fraud than it once was. Technology is growing much more proficient at detecting fraud and minimizing losses.
There are various tactics for reducing chargebacks caused by criminal fraud.
- Use fraud filters and customize the rule sets to reduce risk without losing revenue to false positives.
- Implement a multi-layer approach to fraud management. Use complimentary tools to create comprehensive protection. This might include such things as AVS, card security codes, 3D Secure, IP tracking, velocity limits, and more.
- Sign up for chargeback alerts. Various issuing banks have joined chargeback alert networks. When a cardholder from a participating bank disputes a transaction, the bank will alert the merchant instead of filing a chargeback. This allows the merchant to refund the transaction and avoid the chargeback.
Mitigating Friendly Fraud
Friendly fraud is a relatively new concept and difficult for even the most seasoned business owner to grasp. The idea that authorized transactions from seemingly loyal customers could actually be fraud is hard to comprehend.
Friendly fraud can originate from several different things, but can generally be lumped into two categories: intentional and accidental friendly fraud.
| Potential Causes of Friendly Fraud | |
| Intentional | Accidental |
| Cardholders experience buyer’s remorse and want to lessen their debt load | Cardholders mistakenly believe the bank can liaise with merchants on their behalf |
| Transactions don’t qualify for a traditional refund so cardholders request chargebacks | Cardholders contact their banks to simply gather additional information and banks respond with chargebacks |
| Cardholders set out with the intention to get something for free when they make the purchase | Cardholders don’t recognize or remember a purchase and assume it’s fraud |
Because chargebacks were invented to protect consumers from criminal activity and the majority of chargebacks are classified with reason codes that imply an unauthorized transaction, it’s easy to assume criminal fraud—not friendly fraud—is the biggest threat.
In reality, fewer than 10% of chargebacks are likely the result of criminal fraud. This is because modern technology is so adept at identifying and deterring activities that commonly result in chargebacks.
Friendly fraud, on the other hand, is undetectable with traditional fraud management tools. Consumers have learned to exploit loopholes in the chargeback process and make falsified claims to hide their unscrupulous behavior. For example, they’ll falsely claim the item wasn’t delivered, the purchase wasn’t authorized, or the service wasn’t as described—when in reality, the merchant had delivered exactly what was promised.
As a result, up to 86% of chargebacks could be friendly fraud.
Unfortunately, because a friendly fraud chargeback originates from an authorized purchase made by the cardholder, it is hard to prevent. However, there are certain things merchants can do to protect their bottom line.
- Dispute known cases of friendly fraud. Challenging illegitimate chargebacks helps recover lost revenue.
- Make sure your business is easily identifiable by the billing descriptor (the short explanation that appears on the cardholder’s statement).
- Prominently display your contact information on the website and acknowledge all communication attempts promptly. More than 80% of confirmed friendly fraudsters claim they filed a chargeback out of convenience. Make sure it is just as easy to contact you as the bank.
- Consider a no-strings-attached cancelation and refund policy. The more consumer-friendly your practices, the fewer illegitimate chargebacks.
Chargebacks Will Happen…Be Prepared
Despite your best efforts, chargebacks will happen. No one can account for persnickety and impossible-to-please customers. However, with the right course of action, it’s possible to minimize the impact of chargebacks on your growing business:
- Don’t be ashamed. Chargebacks are a fact of life for nearly all merchants in all industries. They’re nothing to be ashamed of. However, that doesn’t mean you should just accept chargebacks as a cost of doing business.
- Don’t relax. Fraud is a dynamic problem. Fraudsters create new strategies faster than developing technology can respond to them. What works today might not be effective tomorrow. Merchants need to remain proactive, constantly implementing new techniques and keeping up-to-date with industry changes.
- Create a risk mitigation plan. You don’t want to wait until chargebacks become an uncontrollable issue. Take preemptive action by addressing all three sources of chargebacks now.
- Consider getting professional help. When it comes to chargeback management, mistakes can be expensive and incur long-term consequences. Look for tools and services that will compliment your own in-house efforts to ensure comprehensive protection.
By adopting these revenue-saving strategies, you can help ensure that your new eCommerce venture will be a success, right from day one.
