As a business owner, you are probably aware that your relationship with a customer doesn’t end right after they’ve completed their transaction. As soon as a customer decides to make a purchase, a series of actions take place. Even though converting a customer is widely regarded as the “finish line,” the truth is that things can still go wrong, like foggy shipping details or unreachable customer service. This can lead to the dark side of a completed payment: chargebacks.
Read further to learn about:
- What exactly is a chargeback?
- Chargeback vs. Refund
- Cost of chargebacks
- Chargeback process
- Chargeback response time
- Ways to prevent chargebacks
What are Chargebacks?
A chargeback is a charge that is returned to a payment card after a customer successfully disputes an item on their account statement or transactions report. Essentially, a chargeback is a disputed transaction initiated by a customer after a product or service has been purchased. A chargeback may occur on debit cards (and the underlying bank account) or on credit cards. There are many reasons that a cardholder can be granted chargebacks.
The chargeback process is supposed to protect consumers from unauthorized transactions; however, this system is sometimes abused by customers in order to obtain a refund. As a merchant, it is vital to understand what chargebacks entail, the chargeback process, and how to avoid them in the future!
Chargeback vs. Refund
A refund is when the business returns funds to the customer, whereas a chargeback is when the customer’s bank or credit card provider reverses the charge and pulls back the funds from the business.
First contact: For chargebacks, the cardholder contacts their card issuer. Then, the issuer creates a formal dispute case via the relevant card scheme. For refunds, the cardholder contacts the merchant directly to request a refund.
Time: Depending on the circumstances, it can take a few days to several months to dispute a chargeback. With refunds, it typically takes a few days at most.
Cost to merchant: Banks initiate chargebacks at the request of the cardholder and are responsible for gathering the funds from the merchant’s account and returning them to the customer. Refunds involve the merchant voluntarily repaying their customer.
Reputation: Chargebacks pose a greater reputational risk to merchants than refunds. While refunds are monitored, they are often the result of a direct resolution between customer and merchant. Chargebacks require a more costly and detailed process to resolve and can be a result of fraud.
Revenue loss: In both cases, the merchant loses the sale, along with the processing fees for the original transaction. However, merchants can also be charged additional fees for chargebacks and can possibly face financial penalties.
Expertise: As a result of their complex and costly nature, chargebacks require a significant degree of expertise to facilitate, along with great knowledge of the regulations, processes, and possible penalties involved. On the other hand, refunds are relatively simple and can be resolved without any involvement from another party.
Cost of Chargebacks
Chargeback fees typically cost between $10 and $50, depending on the merchant’s agreement with their acquirer. For high-risk merchants, fees can be as high as $100. When you add these fees up with all the other hidden and indirect costs, companies often lose more than twice the transaction amount for each chargeback! These expenses may include:
Transaction Fees: Every time you process a payment, you pay a transaction fee to your payment processor and an interchange fee that goes to the issuing bank. On average, these fees range from 1.5-4% per transaction, and if that transaction results in a chargeback, it’s essentially wasted money.
Operational costs: There is a lot that goes into processing an order, especially in e-commerce. With everything involved, these costs typically amount to about 20% of merchant revenue. This revenue is lost when a charge is reversed.
Marketing and acquisition costs: Most sales made don’t come for free. No matter how much a merchant spends on marketing and advertising, that is some revenue lost. Every time a hard-earned sale disappears due to a chargeback, the money spent to get that customer to make a purchase goes down the drain.
Chargeback Process
1. The customer files a dispute
Once a customer sees a charge on their account statement that they believe to be fraudulent, they file a dispute against the charge with the bank or financial institution that issued the credit card used for the purchase.
2. The issuing bank initiates the chargeback
When the customer disputes a charge, the issuing bank begins the chargeback process.
3. The business has the chance to refute the chargeback
As soon as a customer requests a chargeback, their bank will reach out to the business’s bank and give them a heads-up that the chargeback has been requested. During this time, the business has the opportunity to provide any evidence that refutes the customer’s claim that the charge is legitimate.
4. The bank makes a decision
The issuing bank will review evidence on both sides of the chargeback dispute and render a decision about whether or not to proceed. At this point, if the business declined to provide any evidence to support the charge’s validity, the issuing bank generally will approve the customer’s request for a chargeback.
5. If the issuing bank rules in the business’s favor…
If the cardholder’s bank decides the charge was valid and declines to proceed with the chargeback, the funds are not returned to the customer. If the issuer has already credited the cardholder’s account for the disputed amount before the charge was investigated, and the charge is found to be valid, those funds or credit will be removed again from the cardholder’s account.
6. If the issuing bank rules in the customer’s favor…
If the bank determines that the customer has legitimate grounds to request the chargeback, the funds are withdrawn from the business’s account and credited back to the customer.
7. Arbitration may follow the decision.
If the bank decides in favor of the business, and the customer still wants to fight for the chargeback, the customer has the option of pursuing arbitration. This takes the issue to the credit card company itself. The credit card companies have the final word in a chargeback dispute.
Chargeback Response Time
The chargeback time limit is a fixed period in which all parties involved in the dispute can respond at any phase of a chargeback process. Banks, cardholders, and vendors are required to adhere to the card network’s stipulated dispute timeline if they wish to initiate a chargeback or contest a claim.
On the consumer side, the filing deadlines are fairly generous. From the original transaction or expected delivery date, cardholders typically have up to 120 days to file a dispute. There are a few exceptions, but in most cases, 120 days is the rule.
Generally speaking, merchants will have 20-45 days to respond to each chargeback phase.
6 Ways to Prevent Chargebacks
1. Prioritize security for online and in-person payments
Since chargebacks commonly occur as a result of credit card fraud, making security a top priority is the most impactful thing businesses can do to maximize the amount of chargebacks. Make sure to consult your payment provider, regularly update your point-of-sale (POS) software, opt for more secure card transactions, and require customer signatures and PIN numbers.
2. Have clear return and refund policies
Many chargebacks happen because customers would rather not go through the trouble of returning an item or asking for a refund. Encourage customers to go through the proper channels for returning a product they don’t want, instead of just giving up and disputing the charge with their bank. Make sure to create an easy, low lift, accommodating return policy and communicate it clearly to your customers.
3. Keep online inventory updated
If a customer is able to complete a transaction for a product that is out of stock, you run the risk that the customer will initiate a chargeback instead of coming to you for a refund. Stay diligent about keeping online inventory up to date.
4. Have clear product descriptions
It is common for customers to believe the product they received doesn’t match its online description. This is never good for businesses. Spending some extra time crafting thoughtful product descriptions, in addition to including realistic photos or videos, is a worthwhile investment that can help prevent chargebacks!
5. Manage shipping expectations
Consumers will often initiate a chargeback if they think a product they ordered is lost in the shipping process or unlikely to arrive at all. You can lessen the risk by providing customers with clear shipping details including:
- Which shipping carrier you’re using
- Confirmation and tracking numbers
- Delivery time expectation
- Instructions on whom to contact if they stop receiving shipping updates or their order doesn’t arrive
6. Be accessible
Most of the time, chargebacks happen after someone has tried and failed to get the business to engage with them about the problem. Establishing a quality customer service function for your business is the best way to ensure that, in the event of a problem, customers talk to you instead of their credit card company or bank.
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