Estimated read time: 8 minutes, 15 seconds
Picture this. You’re checking your credit card statement and see a charge that you don’t recognize.
What do you do? You file a complaint with your bank, of course.
This is called a “chargeback”, and if you’re an e-commerce merchant, they can cost your business—big time.
Heartland Payment systems estimate that around 0.01% of all transactions end in a chargeback. 0.01% doesn’t seem like much, right? But in 2016 alone, chargebacks cost the e-commerce industry an estimated $6.7 billion in revenue.
And the number is on the rise.
The other piece of bad news for e-commerce merchants is the majority of chargeback claims are fraudulent.
But there is a way to protect your business. Through clear instructions on your website and a watertight payment processing solution, you can minimize the damage chargebacks can do to your ecommerce business.
In this guide, we’re going to look at:
- What are chargebacks, and how do they work?
- What is the impact on software companies?
- Best practices for reducing chargebacks
- Why is it better to partner with a full-service e-commerce partner
Let’s dive in.
What are chargebacks, and how do they work?
A chargeback is where a customer files a complaint with their bank over a charge on their payment card. They were originally created to protect customers against fraud, stolen credit cards, and mistaken charges.
But how chargebacks are being used has changed in recent years.
Chargebacks are now increasingly linked to online fraud, so much so that 86% of chargeback disputes are considered fraudulent. If that’s not bad enough for merchants, only 14% of customers contact a merchant first before filing a chargeback dispute, and 58% of customers never contact the merchant at all.
So, how do they file their chargeback? Well, they go straight to their bank to complain.
Let’s get one thing clear: a chargeback is not a refund—it’s a dispute. If a customer files a complaint against a merchant and wins the case, their transaction is reversed, and the customer gets their money back from the merchant’s bank.
Every time a chargeback is filed, there must be a reason behind it. That’s why all chargebacks come with a 2-to-4-digit alphanumeric reason code from the customer’s issuing bank. Reason codes are important because they help merchants see why the chargeback has been filed so they can prepare to fight the charge.
Pro-tip: You can run your reason code through this scanner to see the exact reason your customer has filed the chargeback.
Here’s a typical scenario of how a chargeback may happen to your e-commerce store.
- A customer visits your ecommerce store: They like the look of your products and make a purchase.
- The customer then files a chargeback: At the end of the month when the customer is checking their credit card statement, they might flag up a transaction they don’t recognize/never authorized. They jump on the phone and contact their issuing bank and ask them to look into the charge for them.
- The customer’s issuing bank takes over: And contacts your bank. The customer’s bank will ask your bank for all kinds of proof that you sold the product to the customer, and evidence they received the goods. This means you’ll have to keep records of proof of delivery, invoices, and transaction receipts. Seems easy enough, right?
- The bank will then make a decision: On whether the proof you’ve provided is good enough. If they believe that the purchase was invalid (i.e. the customer didn’t make it), then…
- The customer gets their money back: through a process called arbitration. If their bank feels like their purchase was invalid, then they’ll be refunded—from your account. If the customer did make the purchase and then filed a fraudulent complaint, you’ll not only lose the cost of the purchase, but they would’ve also received the goods they ordered. For merchants, chargebacks can be a lose-lose scenario.
What is the impact on software companies?
Small-business owner Dean Thompson told the Wall Street Journal that a chargeback dispute once hit his business.
While looking at his company’s bank account, he was shocked to see that the balance had dropped. By $3000. Without warning.
The reason? One of his customers had disputed his charges. He said it took more than 12 hours to prove that his business had provided the services to the customer, and the fee was valid.
“For a small business owner..it hurts my ability to perform for other clients,” he said.
The impacts of chargebacks on software companies can be huge.
Every time a customer files a chargeback, it can end in three ways. Either the chargeback was real fraud, friendly fraud, or it was a product/service issue.
And each time a merchant is hit with a chargeback, the costs add up. A merchant may be out of pocket for a bunch of different expenses like:
- Standard chargeback fees: Every time a customer files a chargeback, the merchant must pay a fee to cover admin costs to follow up on the complaint (even if the customer withdraws the dispute.)
- Lost revenue: If a customer files a fraudulent chargeback, not only will the merchant lost the revenue from the purchase, but they’ll lose their goods to the customer as well.
- Fines: Chargebacks are closely monitored. If a merchant exceeds their bank’s chargeback threshold, they can be fined. For example, Visa has a standard chargeback threshold. If a merchant exceeds it, they’re put on an enforcement period, where they could be subjected to a $25,000 review fee.
That’s why merchants must understand how chargebacks can affect their cash flow and profits.
You might be thinking; if you get a chargeback, you can just fight it, right? Wrong. Prevention is always better than a cure when it comes to chargebacks. Here are some of the reasons why you should aim to prevent chargebacks altogether—before a customer dispute is ever filed.
It takes a ton of time.
Remember the example from small business owner Dean Thompson from earlier? It took him more than 12 hours to resolve a single chargeback dispute from a customer.
To successfully dispute a chargeback, you need time to prepare your case. If you’re a small business with limited resources, it may not be possible to spend so much of your time fighting chargebacks.
The chargeback might be your fault in the first place.
Despite what you may be thinking, Chargebacks aren’t always dishonest disputes from customers. Sometimes, they’re innocent mistakes made by customers, and this can happen if your business name isn’t clear on their bank statement.
That’s why it’s crucial to make sure you make your DBA Name clear to your customers the moment they purchase a product. To cover your back, notify your customers after their purchase what they should expect to see on their bank statement.
For example, Ahrefs uses full-service ecommerce partner FastSpring to handle their payments. They alert their over email customers what name they need to watch out for on their statement after their purchase to avoid any confusion.
Sometimes, it’s not worth it.
Even if you take the customer on and win the battle, chances are, they’ll never buy from you again.
Fighting chargebacks, especially for smaller merchants, won’t result in repeat business from the customer who has filed the dispute. Ask yourself, is the time spent fighting this charge worth the effort it’s going to take my business?
Best practices for reducing chargebacks.
It’s not all doom and gloom for merchants when it comes to chargebacks.
Although there isn’t a watertight solution to preventing chargeback disputes, there are some measures you can put into place to minimize it happening to your company. These include simple steps like:
- Keep detailed proof of all purchases
- Use an online payment processor/payment gateway on your site, so the card being used by the customer has its AVS verified on file
- Make sure your DBA Name is clear
- Be as transparent as possible with the products and services you’re selling on your site. Add as much detail as you can so a customer isn’t confused when their item arrives
- Have a concise, easy-to-access return policy on your website
- Use a trackable delivery service that also requires the customer to sign for their item when it’s delivered
Pro-tip: If you do get hit with a chargeback, get in front of it early. Make sure you watch out for any messages of emails from your payment processor or bank asking you about a chargeback dispute. If you don’t respond quickly, it’s likely the banks will take matters into their own hands and refund the purchase to the customer.
Why is it better to partner with a full-service ecommerce solution.
When it comes to chargebacks, preventing them is better than fighting them.
That’s why it makes sense to partner with a full-service e-commerce solution—they can prevent chargebacks from happening in the first place.
By using a full-service ecommerce solution, merchants are (mostly) covered against chargebacks. FastSpring has a strict account acceptance policy for detecting fraud that stops chargebacks from happening in the first place.
Partnering up with a full-service ecommerce partner makes sense. It’s is one of the best ways
to prevent chargebacks altogether. Plus, handing over the responsibility of chargebacks gives merchants more time to do what they do best—spend time making their sites into revenue making machines.
Oh, and FastSpring also has the lowest chargeback rates in the industry, which means more money in a merchant’s pocket!