Payment guides

A merchant’s complete guide to chargebacks

Notwithstanding regional differences and the increasing popularity of alternative payment methods, the vast majority of transactions are still being paid with credit and debit cards. In order to compete with new competitors in the fintech arena, banks offer competitive card deals to consumers, one of the reasons which leads us to believe that credit cards will remain preferred online payment method in the near future. Accepting credit card payments is certainly cost effective. Cards offer convenience to e-shoppers, card payments increase basket size and often guarantee a higher ticket purchase at checkout.

Having said this, accepting card payments can get rather complicated for retailers who just started selling their products and service online. E-commerce offers merchants limitless opportunities to expand their geographical footprint. However, there are some risk factors one has to take into consideration, one of which is the prevention of so-called chargebacks.

Although many merchants learn through experience, this paper is meant as a guide to raise merchants’ awareness about the risks and losses their business may suffer, as a result of unexpected chargebacks.

What’s a Chargeback?

When a bank issues a credit or debit card to one of its customers, it is known as the “issuing bank”. In order to protect its customers from fraudulent transactions, the issuing bank allows cardholders to notify the bank and file a complaint in the form of a chargeback. A chargeback is filed when a cardholder discovers an inconsistency in their banking statement. The cardholder is allowed to dispute the transaction.

Once a chargeback form has been filled out and submitted to the bank by the customer and the transaction is deemed fraudulent, the issuing bank will immediately refund the amount of the transaction to the cardholder. The issuing bank will then contact the merchant’s bank (acquiring bank) to redeem the funds. If the merchant isn’t able to provide evidence that the transaction was indeed legitimate, the transaction amount is deducted from the merchants account.

The fees for a merchant incurring a chargeback can range anywhere between £0 to £100, depending on the terms set out by acquiring bank or contracted payment service provider (PSP). This sum is usually payable, regardless to whether or not the merchant is able to prove that the transaction was legitimate. There are associated costs in handling the disputed amount which either the acquiring bank and/or the PSP will have to cover. On the other hand, if the merchant is able to provide evidence which proves that the cardholder is wrong, the merchant isn’t charged, besides the fee for incurring the chargeback.

For evident reasons, merchants should avoid incurring chargebacks. Apart from chargeback fees, merchants risk losing money when products aren’t returned, not to mention shipping costs and a missed opportunity to sell the product to other customers. It is obvious that chargebacks have a negative effect on a merchant’s revenue.

In a worst-case scenario, the merchant’ s chargeback to sales ratio rises above a certain threshold or count for a sustained period of time, which is when card schemes (i.e. Visa, MasterCard, American Express) list the merchant as fraudulent. Besides the reputational damage, these measures jeopardise the merchant’s processing account and its ability to continue accepting payments.

Why would Cardholders file Chargebacks? 

Below are some common examples and scenarios of why a chargeback could occur. It is important for merchants to be aware of the different scenarios and implement internal policies and procedures to prevent these from happening.

Fraudulent Transactions

The most common reason for cardholders to dispute a transaction and file a chargeback is when his/her credit or debit card is charged for a transaction without his/her knowledge or consent. In this case, the merchant is held responsible and is liable for the chargeback amount, unless the merchant can prove that the cardholder agreed to make the transaction. These types of chargebacks can be avoided if the PSP and/or merchant acquirer implements solid risk management and fraud detection solutions

Physical and ID Theft

A physical credit card is stolen, or used by a person other than the cardholder without consent.

Phishing

Credit card and cardholder information is stolen online via “phishing” or other elaborate credit card scams.

Refunds or Credit not processed by the Merchant

This occurs when a cardholder makes a purchase and returns the product, because for some reason the product or service doesn’t meet the shopper’s expectations. The merchant fails to refund the payment transaction. Such chargebacks can be avoided by having the correct procedures in place to ensure all refunds and credits have been processed, including a follow-up and a cardholder’s confirmation receipt.

Why would Merchants fail to refund the payment?

  • The product was “returned”, but not received by the merchant.
  • The merchant failed to initiate a refund or credit, due to complacency or mismanagement.
  • There was a fault with the acquiring bank or PSP’s payment gateway, connecting the merchant to the acquiring bank.

Product or Services not received

A significant percentage of chargebacks are triggered by the fact that cardholders do not receive the goods or services they purchased. The majority of these chargebacks can be avoided by using a reliable fulfilment centre or postal service.

What causes products not to arrive at their destination?

  • The merchant’s fulfilment centre or shipping service failed to post or ship the product, or the item was lost in transit to the customer or the ordered product is delivered at the wrong address.
  • The product was delivered and left on the porch of the cardholder’s address and was stolen.
  • The merchant was unable to fulfil the order due to a lack of stock, bank holidays, understaffing of employees or other reasons preventing the order from being fulfilled.

Technical Issues

Some chargebacks are caused by technical issues during the checkout and payment process. Communication errors on the gateway between the acquiring and issuing at the moment of purchase. Most of these chargeback cases may be avoided by using a reputable and secure payment gateway.

Common technical issues:

  • Transaction time-out, which may result in a cardholder being charged, while the authorisation is displayed as ‘declined’.
  • Reloading of checkout page, which may result in a customer being charged twice for the same purchase, resulting in duplicate transactions.
  • A merchant’s website or shopping cart hasn’t been integrated correctly with the payment gateway.
  • Human error, when entering card details over the telephone and making a mistake in the amounts charged or in the back office of the payment gateway.

The chargeback procedure

It’s surprising how many merchants are unaware of the correct chargeback procedures.

The stages of a chargeback process are:

Stage 1: Once a cardholder has identified a transaction on their credit card statement, the issuing bank is contacted and the cardholder files a chargeback.

Stage 2: The issuing bank will verify whether or not there are grounds for the cardholder’s filed dispute. If there are no grounds and the bank declines the chargeback request, then the cardholder is charged a processing fee and the process ends here.

Stage 3: If the issuing bank accepts the request to file a chargeback, the cardholder is immediately provisionally credited the amount of the original transaction. The Issuing bank then initiates the chargeback process and requests that the acquiring bank returns the funds to cover the provisional credit to the cardholder.

Stage 4: The acquiring bank, or the merchant’s sponsoring bank, then checks the validity of the claim. At this stage, the merchant is notified that a chargeback request has been received.

Stage 5: The acquiring bank then notifies the merchant about the chargeback. If the acquiring bank deems the chargeback invalid, the acquiring bank will inform the issuing bank and the chargeback is declined

Stage 6: If the chargeback is declined by the acquiring bank, the issuing bank is notified and the provisional amount credited to the cardholder is returned to the issuing bank. If the chargeback is deemed valid, the amount of the chargeback is deducted from the merchant account by the acquiring bank and the amount is to be sent to the issuing bank.

Stage 7: If a processing error has occurred, the amendment is sent to the cardholder’s issuing bank for representation.

Stage 8: At this stage, the merchant is requested to provide documentation, as evidence which proves the chargeback is void. If the documentation contains satisfactory evidence, the chargeback is rejected and the cardholder will once again be charged for the original transaction amount. If the evidence isn’t convincing, the cardholder receives the sum quoted in the chargeback from.

The chargeback procedure can last anywhere between 5 weeks to 6 months. If the merchant doesn’t have the correct procedures in place, the chargeback process can get expensive and stressful.


Chargeback Costs

Despite the fact that card payments provide merchants with many added benefits over alternative payment methods, we have seen in the previous chapter how chargebacks can become a challenging factor in a business’s profitability and growth.

Credit cards were not designed to be used online, they were intended to be used face-to-face. Now that consumers increasingly use their credit cards for relatively anonymous online Card-not-Present (CNP) payments, the majority of merchant account agreements place the liability for fraud with the merchant. Whether the transaction is legitimately fraudulent or a malevolent effort on the cardholder’s part, the merchant is still liable. The reason behind this liability issue is that card schemes base their payment networks on trust between the cardholder and the card scheme.

Chargeback fees vary widely, depending on a wide range of factors; the industry in which the merchant operates, previous processing history, the merchant’s business model, business location, the currency being processed and several other risk factors which the merchant acquirer or PSP needs to take into consideration. Chargeback fees also depend on the merchant’s relationship with the acquiring bank or PSP. However fees may range anywhere from £7 to £150 or more, per chargeback.

In the case of Point- of- Sale (POS) or Card Present transactions, where both the cardholder and the credit card are physically present, liability changes. In these scenarios, the liability for chargebacks is transferred to the credit card institutions.

The damage caused by chargebacks isn’t only financial. If the amount of chargebacks rise beyond a specific threshold (% of transactions) the merchant risks to be flagged as fraudulent and as a consequence could end up on a card schemes’ blacklist. Being flagged as high-risk or as fraudulent has severe consequences; chargebacks fees may increase significantly at the acquirer or PSP’s end, which may result in the termination of a merchant account.  Risk Management and Reporting tools will notify acquirers automatically if a merchant is blacklisted, after which it is up to them to accept or terminate a merchant account.

Card-Present (CP) Transactions versus Card-not-Present (CNP) Transactions

In the case of CP transactions, a cardholder pays for a product or service at the time of purchase. The cardholder is required to swipe, sign, place the card on top of an RFID or NFC reader, or enter a PIN code into a terminal. If a merchant follows best-practices, the shopper is asked for identification to enable the merchant to match the name on the credit card with the cardholder, before allowing the payment to take place. Through this verification method, the merchant excludes the possibility of a cardholder claiming he/she wasn’t present during the moment the transaction took place. As a result, merchants on location will pay a much lower chargeback fee than online merchants who sell via e-commerce. The number of chargebacks are also significantly lower for CP transactions and the acquiring bank runs limited risk.

In the case of CNP transactions, payments are made over the internet or over the phone in relative anonymity, with a higher risk of having a cardholder deny the transaction.  The cardholder will file a dispute with the issuing bank, which is referred to as a retrieval request.

What is a Retrieval Request?

A retrieval request is a process which allows a cardholder, issuing bank or card scheme to question a transaction which has appeared on a cardholder’s bank statement. When a chargeback occurs, it is accompanied by a retrieval request.

Once a retrieval request has taken place, the merchant produces a sales draft of the transaction. Merchants should always keep a record of all sales drafts, as required by most card brands. Sales drafts include the cardholder’s name, account number, date of transaction, sales amount and reference number. Merchants should also supply additional documentation which could help prove that the transaction legitimately took place. This could include a signed invoice, signed contract or agreement or any other documentation linking the transaction to the cardholder. It is crucial that a merchant responds to retrieval requests within a specific timeframe, usually 10 days before a chargeback is filed.

The purpose of providing additional documentation is to prove the cardholder did in fact agree with the purchase. A signed copy of a postal receipt isn’t enough, as the cardholder may not have agreed to purchase the goods, but they were still delivered and charged for.

If an online merchant isn’t able to produce a detailed and specified sales draft, the large majority of retrieval requests will turn into chargebacks.

Chargeback Red Flags

Be aware of warning signs, so-called red flags, which may require extra attention

  • Double-check new customers, especially if they order bulks of one product
  • Watch out for billing addresses which differ from the delivery address
  • Multiple orders with different credit cards, all on the same delivery address.
  • Multiple orders within a short time-period (days)
  • Expensive orders, demanding fast delivery
  • Orders with different credit cards, placed from the same IP address
  • Oversea shipping (AVS can’t match international addresses)
  • Orders made with one credit card but destined for different delivery addresses

“Friendly” chargeback fraud

Friendly chargeback fraud, also known simply as chargeback fraud, is when a cardholder abuses the chargeback dispute process. This occurs when a customer knowingly makes a purchase, authorises the purchase, receives the goods or service, and then files a chargeback for the product or service which was received.

It is important to note there are two types of friendly chargeback fraud. In the first scenario, the customer is the one who is dishonest, which is referred to as intentional friendly fraud. In the second scenario, the cardholder inadvertently or unknowingly commits friendly chargeback fraud. In both cases, depending on the chargeback reason code, it is easier for merchants to dispute the chargebacks, because the goods are almost always delivered and received.

Intentional friendly chargeback fraud: a cardholder purposely tries to make profit out of legitimate purchases.

Unintentional friendly chargeback fraud is when a cardholder files a chargeback for a legitimate purchase, without realising it is not valid.

There are a number of ways to help prevent fraud. 

Reduce and Prevent Chargebacks?

Chargebacks can be one of a merchant’s main nuisances. Although a legitimate and ethical merchant can win chargebacks by providing the correct and proper documentation on time, it is usually not worth the time disputing a chargeback, especially in case of small transactions. However, in case of high value sales or large ticket items, it makes perfect sense to dispute a chargeback.

There are several ways to reduce and prevent chargebacks. Apart from a helpful and responsive customer call centre, high quality products and/or services and correct processes and procedures, we would advise merchants to:

  • Make sure you are PCI-DSS Compliant
  • Educate and train your employees. Raise their awareness around (recent) fraud scenarios.
  • Provide customers with easily accessible contact information and a fast, responsive customer service. This will ensure that all complaints are made to the merchant, instead of to the issuing bank. This allows the merchant to solve the customer’s problem and prevents a dispute.
  • Implement a well displayed and fair return and shipping policy. It is important that the customer is aware and agrees with the company policy, before making a purchase.
  • It is good practice to always send a confirmation or purchase email to customers, which includes an invoice. This will ensure the customer has a record of the transaction on file. It’s also best practice to send a shipping confirmation so that the customer knows the product is on the way.
  • Make sure the billing descriptor clearly describes the merchant’s business name, website address or business activity. The billing descriptor will show up on the cardholder’s bank statement and prevents chargebacks triggered by cardholders not recognising the purchase. It’s also possible to include a customer service phone number in the billing descriptor, which the cardholder can call if he/she doesn’t recognise the transaction.
  • In some circumstances, mostly for low ticket items, it may be more economically viable to offer the customer a refund or store credit as there are no grounds for a chargeback if the funds have already been refunded. This will avoid the additional chargeback fees and time necessary to deal with the requested paperwork justifying the purchase.
  • Offer the best quality product and service possible and offer shoppers a detailed product descriptions, to avoid customers from ordering a product which doesn’t meet their expectations, based on the merchant’s website.
  • Customers that forget about the subscription or trial period will usually charge back or call the merchant and request a refund anyhow.
  • In some circumstances, it is possible to pre-authorise a transaction and only capture the funds, once a merchant is sure the customer is happy and has received the product or service.
  • Use Verified by Visa, MasterCard SecureCode and American Express Card Identification digits to reduce the chance of chargeback risk exposure.
  • Use Address Verification (AVS) to verify the Cardholder’s address.
  • Demand entry of a CVV, CVC or CID authentication number for all online transactions. Be aware that it is a violation of card association security standards to store these numbers.
  • Implement risk management solutions.
  • Based on your past experience with customers, you might want to create and update your own ‘good customers’ and a ‘bad customers’ list.
  • Use VISA Account Updater (VAU), a tool tool designed to reduce the number of declined transactions associated with recurring payments and the chargebacks associated with processing inaccurate information.
  • Use IP Geolocation and Device Authentication Tools. Especially when you sell high-cost products and services, you want to verify whether the data entered by the customer, matches his/her geo-location.

If you would like more information on ways to reduce chargebacks, please contact Centus and speak to one of our payments specialists.



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