Chapter 3:
Understanding Chargebacks

The Chargeback Process

As we touched on earlier, a chargeback happens when a customer files a dispute with their credit card issuer over a charge on their account.

Once a chargeback request is filed, a series of steps takes place:

• The credit card issuer contacts the business’s account provider.
• The business submits documents to prove the chargeback is invalid.
• If the business loses the chargeback, the account provider reverses whatever payment was made to the business and charges an additional chargeback fee.

Chargebacks can be devastating for businesses, especially small businesses. Not only do you often lose the value of a product plus shipping expenses, but chargeback fees can reach $100 or more per transaction.

And if a card issuer decides you incur too many chargebacks, they may raise your fees or remove your ability to accept credit cards entirely.

That can be the beginning of the end for a small business.

Types of Chargebacks

Chargebacks can fall into three categories: legitimate chargebacks, friendly fraud and chargeback fraud.

Legitimate chargebacks

Legitimate chargebacks occur when a business is genuinely at fault — for example, if the business charged the customer without fulfilling the sale or if the business shipped a different product from what the customer ordered.

Friendly fraud chargebacks

As we mentioned earlier, friendly fraud is a gray area, where the reason for the chargeback isn’t legitimate, but it’s also not malicious. For example, the customer simply may not recognize a particular charge or business’s name on their credit card statement.

Chargeback fraud

You’ve already learned that chargeback fraud happens when a customer files a chargeback with the express intent to defraud. For example, a fraudster may claim that an item was never received, when in fact it was. Or the customer may place an order with their own card but then claim that the card was stolen — and the transaction was fraudulent — all while they’re sitting with the merchandise in hand.

It takes a long time to process and adjudicate chargebacks. For small businesses, it is tedious and frustrating because the onus is on them to prove that the chargeback is invalid. To win a chargeback dispute, businesses need to produce meticulous records and have patience throughout the back-and-forth with the customer and credit card issuer.

Chargeback Fees and Chargeback Ratios

Not only do chargebacks cost time and effort, they can put a significant dent in a company’s bottom line. In addition to lost inventory and shipping costs, chargebacks involve fees and other penalties. The fees vary by payment processor, but they can range from $50 to over $75 per dispute. Multiple chargeback fees can be the death knell for a small business.

In addition to chargeback fees, a bigger problem to worry about is your chargeback ratio.

Your chargeback ratio reflects the percentage of chargebacks relative to overall transactions. The industry standard has been 1% for years, but some payment processors have lowered that threshold, especially for high-risk businesses.

Once your chargeback ratio crosses that threshold, the fees increase and the payment processor may freeze (or even terminate) the company’s account.

But that’s not all.

Once a company’s account is closed with one payment processor, word travels fast. You may have trouble opening an account with any of the other processors. That’s when businesses are forced to accept sky-high processing rates to reopen their account … if they can get approved for payment processing at all.

The best way to handle chargebacks is to prevent them as much as possible.

Chargeback Solutions

Preventing excessive chargebacks from harming your business involves one of two solutions: chargeback protection or chargeback insurance. But what is the difference between these two options?

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  1. Chargeback Protection:
  This solution offers tools to monitor transactions and identify/prevent fraud. It may also cover a portion of the potential losses related to chargebacks.

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  2. Chargeback Insurance:
  This solution guarantees coverage if the fraud solution partner approves a transaction that turns out to be fraudulent and results in a chargeback.

These two solutions are markedly different, so it’s critical to choose the approach that’s best for your business. Not all vendors offer both options, which makes it even more important to carefully select your fraud prevention solution provider.

We’ll help you navigate that important decision in Chapter 5. Before we do though, it’s important to understand why relying solely on fraud filters can backfire … and get you into trouble with your customers.