What is a Chargeback? 2019 Edition
Even if you deal with chargebacks on a daily basis, it’s easy to get confused when talking about them. A simple dispute over an erroneous transaction will look very different from a friendly fraud attempt that goes into arbitration, but they’re both chargebacks. So what makes chargebacks so difficult to define?
A chargeback (sometimes called a "dispute") isn’t a single, discrete, well-defined action, but a process that can play out over multiple cycles.
Everyone, and I do mean everyone, has chargebacks. You're not alone. The rate at which disputes like these occur is astronomical.
Nearly half of consumers initiated a chargeback last year.
In order to communicate clearly and effectively about chargebacks—to banks, customers, chargeback firms, other merchants—it’s important to understand the terms used and how they relate to various stages of the dispute process.
It doesn’t help matters that the chargeback process is undergoing constant change as banks and card networks shift their policies and rules to account for new forms of fraud, consumer expectations, and the ever-evolving ecommerce landscape.
To really understand what’s being talked about when we talk about chargebacks, it can help to revisit the foundational concepts from time to time. Toward that end, we’ve prepared this guide that aims to concisely and comprehensively answer the question: what is a chargeback?
Chargebacks in a Nutshell
The basic idea behind chargebacks is simple. They were created to protect consumers by giving them a way to appeal fraudulent, deceptive, or otherwise improper credit card charges. One of the big motivations behind the creation and standardization of chargebacks across the card payments industry was the growing importance of ecommerce. Consumers wanted to shop online, but were worried about identity theft and credit card fraud. By giving consumers an easy, reliable way to challenge charges that they didn’t believe they really authorized, they were able to shop on the internet without worrying about being victimized by cybercriminals.
A chargeback begins when a consumer sees a charge on their credit card statement that they do not believe they are obligated to pay. They can call the bank that issued their credit card and report the charge as fraudulent, kicking off the chargeback process.
The bank will typically give the customer a provisional credit for the amount of the charge while they investigate the validity of the claim. This may involve a retrieval request, where the issuing bank requests additional information from the merchant or acquiring bank about the charge. The merchant must also acknowledge the chargeback at this point by either accepting it or challenging it. If the chargeback is accepted by the merchant or found to be valid by the issuing bank, the customer will get to keep the temporary credit.
Fairly straightforward so far, right?
Where it gets complicated is when the merchant decides to fight back.
An Overview of Chargeback Types
Before we get into what happens when merchants fight their chargebacks, let’s take a step back and look at the various types of chargebacks that can occur.
Every chargeback must have a reason code associated with it. The major card networks (Visa, Mastercard, Discover, American Express) established these codes to clearly identify the reason the chargeback was requested. Each reason code has certain standards of proof and evidence associated with it that determine whether the chargeback is valid or not.
Generally speaking, the reason codes fall into one of three broad categories:
- True fraud
- Friendly fraud
- Merchant error
True fraud chargebacks are what chargebacks were invented for: unauthorized charges against a credit card by a scammer or identity thief. Merchants cannot expect to fight and win against these types of chargebacks.
“Friendly fraud” refers to customers reporting valid charges as fraudulent to have them reversed. They might do this deliberately, with malicious or criminal intent, or they might do it out of impatience or confusion about how the chargeback process is supposed to work. Merchants should fight these chargebacks every time—with the right evidence, they can be beaten.
Merchant error chargebacks might occur for a variety of reasons. Merchants may be able to effectively fight these chargebacks, but sometimes they are valid on their merits, and can reveal problems or flaws in the merchant’s operations that must be remedied to prevent similar chargebacks from occurring in the future.
Who’s Liable for Chargebacks?
Why is non-acknowledgement of a chargeback default to accepting it as valid? Why is it so important for merchants to understand reason codes and the evidentiary standards associated with them?
Card networks have decreed that merchants hold the liability for chargebacks, and the burden of proof is on them to make the case for why a chargeback should be struck down or reversed.
This may seem unfair, but it makes sense in the context of chargebacks’ reason for existing in the first place (to protect consumer confidence), and it does give merchants agency to respond and fight them.
Chargeback Liability for Retail Merchants
EMV chip-based credit cards made true fraud substantially more difficult during card-present transactions (transactions in which a person's card is physically in-store). It is nearly impossible to clone an EMV chip-based credit card compared to cloning a magnetic strip credit card. If a customer uses an EMV chip card in a retail store, the liability automatically goes to the issuing bank (not the acquirer), as long as the merchant uses an EMV chip terminal for the transaction.
The merchant is not responsible for any chargeback liability arising due to true fraud. But they will be liable for chargebacks arising due to other issues such as customer service issues and merchant errors.
That said, if the merchant is not capable of processing credit cards using EMV chip readable terminals, and the customer has an EMV chip card, the merchant will be liable for the chargeback if a dispute arises.
Chargeback Liability for Card-Not-Present Merchants
For card-not-present (CNP) transactions, like those made online or over the phone, the merchant is liable for all disputes until proven innocent.
But, if an e-commerce merchant uses 3D Secure Technology, and if the transaction is 3D secure verified, the issuing bank is liable for all chargeback disputes that are claimed as not-authorized or fraud. The merchant will still be responsible for chargebacks arising due to customer service or merchant errors. 3D Secure Technology cannot be used by phone-order or mail-order merchants since the customer is not entering the order details in the system.
The Chargeback Process
Let’s walk through the chargeback process again, but this time we’ll do it in a little more detail, and keep going past the default outcome.
- The cardholder disputes a transaction with their issuing bank. The issuing bank extends a provisional credit to their account.
- The issuing bank sends a retrieval request to the acquiring bank to obtain more information.
- The acquiring bank will resolve the dispute with the issuing bank if possible, otherwise they will forward the chargeback to the merchant for their acknowledgement.
- The merchant either accepts the chargeback (the default) or fights it by resubmitting the charge (the term for this is “representment”) along with the necessary evidence to disprove the claim. *Note: A rebuttal letter must be included that summarizes the entire case.
- Based on the evidence, the issuing bank will decide in favor of either the customer or the merchant. If they find in favor of the merchant, the provisional credit will be reversed and returned to the merchant.
- At this point, any party unhappy with the decision can request further review, which puts the chargeback process into the pre-arbitration phase.
- If the banks cannot come to an agreement during pre-arbitration, the process enters arbitration. The card network will examine the evidence and make a final decision.
The back-and-forth of the pre-arbitration and arbitration phases can last for months, and arbitration fees adding up to hundreds of dollars must be paid to the card networks.
When you hear talk of “chargeback thresholds,” that refers to the limits placed by credit card processors on the maximum chargeback rate allowed for their merchants. The threshold is typically calculated as a ratio of chargeback amounts to total revenue, with 1% being a common threshold amount.
Merchants who exceed their chargeback thresholds may have their accounts terminated, forcing them to sign on with exorbitantly expensive “high-risk” payment processors.
How and Why to Fight Chargebacks
Not every chargeback can be stopped. Some are the result of genuine criminal activity, and some come about because of mistakes or oversights on the merchant’s behalf. However, merchants should always look carefully at their chargebacks and represent as many as possible. It’s important to know where your chargebacks are coming from, and to be in the habit of responding and fighting them.
Studying and fighting your chargebacks will help you learn why they’re happening to you, and addressing those root causes is by far the best thing you can do to prevent future chargebacks.
Remember, the cost of a chargeback isn’t just the amount of the disputed transaction.
It also includes the fees, the operational costs you incurred to make that sale in the first place, and the added pressure on your chargeback threshold.
When you add it all up, the true cost of a chargeback can be as much as double the original paid amount.
When you understand what chargebacks are, you can fight them more effectively, learn from them, and take steps to reduce the chances that they will keep afflicting you. Even when choosing a chargeback management firm to deal with them for you, having a solid grounding in the facts about chargebacks will help you know whether that firm is providing you with a good return on your investment.
Regardless of your chargeback experience level with, Chargeback Gurus can guide you to the best possible outcomes for your company. For topic requests, questions or advice, please email us directly: email@example.com