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 ecommerce 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 ecommerce industry an estimated $6.7 billion in revenue.
And the number is on the rise.
The other piece of bad news for ecommerce 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 stop chargebacks from happening in the first place.
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 preventing chargebacks
- Why you should partner with a full-service ecommerce partner
Let’s dive in.
What are chargebacks, and how do they work?
So, what is a chargeback?
The truth is, chargebacks, also known as friendly fraud, are, unfortunately, often far from being friendly for merchants. Even though chargebacks were created initially as a form of consumer protection, chargeback protection is frequently used as a loophole for fraudsters.
Online merchants are particularly at risk for customer chargebacks since they lack the opportunity to look at the physical card before running the transaction. The bottom line is there is less credit card merchant protection with the lack of standard security steps in place (like checking the signature and asking for customer identification).
Common reasons why customers file a chargeback dispute with their bank. Image source
But the way 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. The reason these codes are important is that they help merchants see why the chargeback has been filed in the first place.
An example of some of the reason codes behind chargebacks from Visa customers. Image source
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 ecommerce 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 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 then they contact 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. It 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.
Assuming that the customer is right, chargebacks are a great security measure to protect consumers from crooked merchants. However, if the customer isn’t right, the merchant is still the one with the sour end of the deal. Chargebacks are also referred to as friendly fraud because, in many cases, customers may have genuinely forgotten they made a purchase and create a “harmless” dispute.
There are many situations in which a dishonest customer uses a chargeback to make a profit. Not only do they get to keep the product, but they also get to keep the reversed charge.
The bad news is that whether a chargeback results from “friendly fraud” or an unscrupulous fraudster, the merchant is always the one that loses.
The Most Common Types of Chargebacks
So, how is it exactly that chargebacks happen? The truth is that they can happen for a variety of reasons. Here are some scenarios that may call for initiating a chargeback.
A Fraudulent or Unauthorized Charge
It goes without saying that a customer who sees a charge on their banking statement they never made have every reason to be alarmed. After all, most people agree that the first thing you do when you don’t recognize a transaction on your account is call your bank, right?
Goods Never Received
Unfulfilled goods and services are a common cause of chargebacks. If the customer doesn’t get what they paid for, naturally, they want their money back.
Damaged or Defective Products
In some cases, customers may receive what they paid for; however, some are missing or don’t function as promised. Under certain conditions, customers could easily solve the situation by contacting the merchant directly, but more often than not, they contact the bank instead and request a chargeback.
Incorrect Charge Amount
Honest mistakes happen. In some situations, a technical error or manually entered prices can result in an incorrect charge amount. However, in other scenarios, the customer may be a victim of online merchant fraud.
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.
Even if you were going to try and dispute a case, the process is a huge hassle that takes a long time. 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 so they know 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 were to 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.
There are measures you can put into place to minimize it happening to your company. These include 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
At the end of the day, these steps take time, and that time can add up. This is why many businesses choose to partner with a full-service ecommerce solution that takes care of chargebacks on their behalf. More on this below!
Why You Should 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 ecommerce solution—they can prevent chargebacks from happening in the first place.
By using a full-service ecommerce solution, merchants are 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.