What are chargebacks and how to reduce them

Purchase disputes, which occur when a customer objects to paying for some or all of a purchase charged to their account, can be expensive. The process of investigating them can be time intensive and costly for merchants. Plus, if the dispute is successful, the payment network (e.g., Visa® or Mastercard®) charges a fee for the administrative expenses incurred when investigating and processing the customer’s refund, a process known as a chargeback. If you have a significant number of chargebacks in a short time, your payment processor may charge you additional fees and penalties.

Why chargebacks happen

Purchase disputes can result from a number of situations, including simple mistakes, misunderstandings or outright fraud. If there is difficulty reaching a resolution, the dispute may also be reviewed by the payment networks to determine whether the merchant or the customer ultimately receives the funds.

Here is a closer look at some common scenarios that result in chargebacks:

Fraudulent or unauthorized charges

This is the most common reason for a chargeback. “Now that chip cards have started to replace the old less-secure magnetic-stripe cards, fraud-related chargebacks are usually from online or other card-not-present (CNP) transactions,” says Joe Lamar, Merchant Services product executive at Bank of America.

However, in addition to regular fraud, there is also “friendly fraud,” in which a consumer disputes the purchase despite authorizing and perhaps even receiving it. For example, Jay lent his brother his credit card to purchase a $20 pair of socks. His brother bought the socks along with a $50 hooded sweatshirt. When Jay looked at his credit card statement, he didn’t recognize the charge for the sweatshirt, so he called his bank and disputed the purchase.

Unrecognized charges

This typically happens when a store has a different name from the company brand name. A store called ABC Pastry Shop that sells pastries, for example, uses the name Bakery Express on its receipts. When Daniel sees a charge from Bakery Express, a company he has never heard of, he suspects fraud and files a dispute.

Duplicate or incorrect charges

This could occur when a cashier rings up a purchase twice, for example. Kiran went to his local department store and purchased a pair of work boots using his debit card. A few days later, when Kiran was reviewing his bank account, he noticed there were two charges for the exact amount he paid for the work boots. That error resulted in a chargeback.

Issues with the purchased goods

In this scenario, the purchased goods or services were damaged, defective, not as originally described or not delivered at all. For example, Anna ordered a brand-name video game controller from an online retailer, described as red, transparent and wireless. When she received the controller, it was a standard gray wired controller. Anna tried to contact the seller but was unable to reach them, so she filed a dispute.

How to resolve customer disputes — and reduce chargebacks

Though payment disputes can be frustrating, you should respond to them promptly, says Lamar. “Start with the customer,” he suggests. “Many friendly fraud issues are related to customers who have an issue with their purchase but think it may be easier to dispute rather than working directly with the merchant.” It’s also important to collect proof that transactions were authorized by the cardholder, especially for e-commerce purchases. The more evidence a merchant can provide to support the legitimacy of a transaction, the better their chance of overturning a chargeback. Should you fail to respond — or the dispute is found in the customer’s favor — the funds will be returned to the customer.

The following tips can help reduce the frequency of chargebacks:

• Obtain proper authorizations for all card transactions, such as customer signatures, PINs, address verification or CVV codes (three to four digits found on the front or back of the card).
• Ensure all transactions are approved (not declined) by the issuing bank.
• For online purchases, verify that the cardholder was advised of the purchase details and given the option to confirm or cancel at the time of the transaction. 
• Wait to process transactions until the merchandise is shipped or delivered.
• Ensure all transactions are processed accurately with the proper transaction code and in a timely manner.
• Make sure your registered business name on the payment system matches or is at least similar to the one on the cardholder’s statement.
• Obtain the customer or other designated person’s signature for proof of delivery when merchandise is delivered. 
• For subscription-based transactions, obtain customer acknowledgment and agreement to your recurring transaction agreement, and provide notice to the cardholder prior to each recurring transaction.

When you’re running a business, chargebacks are inevitable. But if you’re prepared, you can reduce their frequency.