Understanding Chargebacks: Why They Happen and How to Avoid Them

For any new business navigating the basics of merchant services for the first time, understanding chargebacks is a crucial component of maintaining a smooth and profitable operation.

A chargeback is essentially a transaction reversal meant to serve as a form of consumer protection from fraudulent activity. However, it can sometimes become a double-edged sword for merchants.

In this post, we’ll dissect the concept of chargebacks, how they occur, and provide strategies for avoiding them.

What Is a Chargeback?

In simple terms, a chargeback happens when a consumer disputes a charge on their credit card statement directly with their card issuer. If the dispute is deemed valid, the card issuer reverses the transaction, pulling the funds out of the merchant’s account and returning them to the customer.

Chargebacks were initially designed as a protective measure for consumers against unauthorized transactions.

However, they have since evolved into a thorny issue for merchants, especially those in the ecommerce space where fraudulent and ‘friendly fraud’ activities are more prevalent.

Reasons for Chargebacks

Chargebacks can occur for a variety of reasons, but the most common ones include:

1. Credit not processed: A customer may have returned an item but didn’t receive a refund, or a cancellation did not result in the expected credit
2. Billing errors: Duplicate charges, incorrect amounts, or other billing mistakes
3. Customer doesn’t recognize the charge: Perhaps they forgot they made the purchase or someone else used their card without their permission. They request a chargeback to get the money credited back
4. Product never arrived: If the order got lost in transit or the customer never received their shipment, they’ll ask their bank for a refund via a chargeback
5. Product was defective or not as described: If the customer feels the product quality was misrepresented or the item arrived broken or faulty, they’ll often dispute the charge to get their money back
6. Transaction was fraudulent: If the customer’s credit card number was stolen and used to make unauthorized purchases, the cardholder will request chargebacks on those transactions–58% of cardholders have fallen victim to fraudulent charges, so it could be a legitimate unauthorized purchase
7. Customer changed their mind: Some customers take advantage of chargeback rights if they have “buyer’s remorse” and want a refund on a product they decided they don’t want

Chargebacks are a frequent headache for merchants because you end up paying costly fees and losing both the product sold and the profit on the sale.

Plus, too many chargebacks can damage your reputation with payment processors and hurt your ability to accept credit card payments.

Impacts of Chargebacks on Merchants

The impacts of chargebacks are not merely financial. They carry a range of negative consequences for merchants.

Lost Revenue: The most immediate impact is the loss of revenue from the reversed transaction.

Fees and Penalties: Merchants often incur additional chargeback fees (on top of numerous standard fees). If a business’s chargeback rates exceed the acceptable thresholds set by the card networks, they may face increased fees or even the possibility of losing their merchant account.

Damaged Reputation: Regular occurrence of chargebacks can damage a business’s reputation and relationship with payment processors and banks.

Administrative Costs: The process of disputing chargebacks consumes time and resources, adding to the operational costs of a business.

How to Avoid Chargebacks

While it might seem like an uphill battle, there are strategies you can start implementing to help reduce chargebacks from occurring in the first place. Some of them are easy and can be implemented right away but some require more effort over a longer period of time.

Provide Excellent Customer Service

Quick, effective, and friendly customer service can resolve many issues before they escalate into chargebacks. Make it easy for customers to reach out and get problems solved.

Clear Communication

Be transparent with your product descriptions, pricing, checkout experience, and policies. Misunderstandings and unmet expectations are often the root cause of chargebacks.

Fast and Reliable Fulfillment

Ensure that orders are fulfilled accurately and delivered on time. Provide tracking numbers and keep customers updated on their order status.

Package Items Securely

Use proper packaging materials and techniques so items arrive intact and undamaged. Damaged goods are a common chargeback trigger. Invest in quality boxes, bubble wrap, packing peanuts, waterproofing, and fragile labels to prevent breakage in transit.

Use Shipping Insurance

Consider insuring expensive inventory being shipped. This protects you financially if the package gets lost or stolen. Insurance makes it less likely for customers to file a chargeback over missing orders. Just provide the tracking number and proof of insurance to dispute chargeback requests.

Secure Your Transactions

Implement advanced fraud detection tools and secure payment gateways. Use AVS (Address Verification Service) and CVV (Card Verification Value) to verify the identity of the buyer.

Require Customer Signatures for Expensive Items

Get a cardholder’s signature for merchandise over $500-$1000. Signatures are required for card-not-present transactions above a certain threshold. While signatures don’t guarantee against chargebacks, they add an extra layer of verification and accountability for buyers.

Hassle-Free Returns & Refunds

A flexible and easy-to-understand return/refund policy can encourage customers to resolve their issues directly with you instead of initiating a chargeback.

Billing Transparency

Make sure your company name is recognizable on credit card statements to avoid confusion. Also, send an immediate email confirmation of transactions.

Proactive Dispute Resolution

If a customer disputes a transaction, resolve it proactively. Sometimes, issuing a refund is cheaper and less damaging than enduring a chargeback.

Treat Chargebacks as Learning Experiences

Look for patterns and tweak policies, product listings, and operations to correct issues. For example, if you get repeated chargebacks for damaged goods, reevaluate packaging or shipping methods.

Training and Documentation

Train your staff to handle transactions properly and document all interactions and sales. Good record-keeping can help you dispute chargebacks if necessary.

Work with Your Merchant Services Provider

Talk to your credit card processing company for advice if chargebacks become excessive. They can assess penalties on sellers with high dispute rates. But processors also have chargeback monitoring tools and fraud protection services to aid merchants.

Final Thoughts

Dealing with chargebacks is part and parcel of running a modern business, especially for online merchants. While chargebacks can’t be completely eliminated, understanding why they occur and implementing effective prevention strategies can significantly reduce their frequency and impact.

Remember, the key to reducing chargebacks is to maintain high-quality customer service, ensure transaction security, and keep open, clear communication channels with your customers. By adopting these best practices, you can protect your business’s reputation, maintain a healthy relationship with payment processors, and ensure your business’s profitability in the long run.