Anatomy of a Credit Card Chargeback

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One of the main reasons the chargeback process was designed was to act as a safety net to increase confidence amongst consumers when using credit cards to make purchases.  When a customer is dissatisfied with a charge on their credit card, they can dispute the transaction through the bank that issued the credit card.  The issuing bank will in most cases open a chargeback that ultimately flows to the merchant’s acquiring bank and on to the merchant.

Chargebacks can happen for a number of reasons, including:

  • Customer didn’t receive the product or service
  • Customer receives a product that is different from what they ordered and paid for
  • Customer doesn’t recognize the merchant’s name or the purchase on their billing statement
  • Customer is double-billed, billed for an incorrect  amount or some other clerical error
  • Customer claims the purchase was not authorized or was made as a result of identity theft

For most credit card transactions, customers have up to 120 days from the date of the sale or the date the service was rendered to dispute a charge.  Once a dispute is opened, resolving it can take 90 days or longer, during which time the funds are withheld from the merchant’s bank account. 

Understanding the Chargeback Procedure

When a chargeback is initiated by a customer, their bank reverses the sale, sending the transaction back to the merchant’s bank and provisionally crediting the customer’s credit card account for the amount of the purchase.  Credit card chargeback rules may be different for every credit card network, and issuing banks usually let the customer know what rules they must follow for handling a chargeback dispute and what they should expect during the process.  Similarly, once the chargeback notice reaches the acquiring bank, the acquiring bank will educate the merchant on their rights and responsibilities in the process.  It is important for merchants to adhere to these rules to protect their rights.   

When the funds for the disputed transaction are deducted from the merchant’s account, the merchant has to decide whether to accept the chargeback or respond to it.  In most cases, the merchant will be allowed to present evidence to support their claim that the charge is legitimate.  The evidence required by the card network depends on the reason for the chargeback.  If the evidence is considered compelling after review by the acquiring bank, the merchant’s bank submits the transaction again to the customer’s bank and passes the information supplied by the merchant to the issuer. 

At this point, the customer’s bank may try to contact the cardholder to discuss the case with the customer.  If they can’t reach them, then the customer’s bank may decide to evaluate the support.  Ultimately, either party can agree with the merchant and accept being re-billed or disagree, in which case the dispute continues into the next phase.  At this point, the merchant can either go ahead and accept the chargeback or provide additional evidence to continue fighting the case.  If they do not have additional evidence but feel the support they have already provided is sufficient, they can also request arbitration by the credit card network.  If the decision is in the merchant’s favor, the customer will be billed for the amount of the transaction and the merchant will be paid.  If the decision is in favor of the customer, the credit previously issued by the bank will be retained and the merchant will not be reimbursed for the transaction. 

The Cost of Chargebacks

The credit card chargeback process can be costly for merchants in terms of fees and lost revenue. Unfortunately, most businesses may have to pay fees regardless of whether or not they prevail in the dispute, which can have a detrimental financial impact if disputes become a common occurrence.  In addition, investigating a chargeback dispute is labor-intensive and tedious, so many merchants just let the chargeback go through rather than fight it, particularly for lower-cost products and services.  The fees assessed to a merchant for a chargeback can include:

  • When a customer disputes a charge, their bank may issue a retrieval request or chargeback to the merchant’s bank. The merchant’s bank may charge a fee ranging from $15 to $35 to manage the case for the      merchant.
  • If the merchant decides to provide evidence to their bank to fight the dispute, the merchant may be assessed a representment fee.  This fee, which also usually ranges from $15 to $35, must be paid even if the evidence is rejected.
  • If a merchant chooses to file an arbitration case, they will be assessed a filing fee which can be hundreds of dollars depending on the card network and current rules.  If they lose the arbitration case, the fees can increase to as much as $500.   Something else to keep in mind is even if they win the arbitration case, the filing fee is nonrefundable.
  • Major credit card networks have limits on the number  of chargebacks allowed before additional penalties or fines are  levied.  If a merchant’s chargebacks  exceed these chargeback-to-sales ratios, they may have fines levied, lose the right to fight their chargebacks, be asked to provide larger reserves or have their credit account terminated, which would affect their ability to open accounts with other payment providers. Ratios are calculated on a monthly basis. Exceeding the ratios for more than 2 months puts a business at risk of being placed on an official chargeback monitoring program,  which can be accompanied by fines that start at $5,000 and go up.

Preventing Chargebacks

There are steps merchants can take to help prevent or reduce the occurrence of chargebacks.

  1. Provide terrific customer service.  Make it as easy as possible for customers to express their concerns if they are not satisfied.  Be sure customer service contact information is easy to find.  Deliver fast response times and offer extended support hours.  Customers would prefer to take their concerns to the merchant first and use the chargeback option as a last resort.
  2. Post return and refund policies clearly and visibly.  Be sure customers know in advance what the policies are.  We recommend creating an acknowledgement checkbox as part of the purchase path, known in the industry as a click-to-accept process.  This requires customers to click on a box to indicate that they agree to the company’s policies prior to purchasing.
  3. Communicate with customers.  If customers know the status of an order, they may be less likely to dispute a charge.  Keep a record of all communications made with customers via e-mail or telephone. This includes when an order is placed, when it is shipped, and when it is delivered, as well as monthly reminders for subscription- or installment-based billings.  In addition, if the service you provide is recurring, you should provide timely reminders of the billing anniversary and contact information for your customer service department if any issues arise.
  4. Respond promptly.  When a customer files a request for additional information about the transaction, known as an inquiry or retrieval request, the issuing bank will automatically process a chargeback if they don’t receive a response from the merchant within an allotted time. We encourage that all businesses respond to inquiries and/or retrievals, as this is a way for a customer to reconcile a discrepancy with a sale before filing an official chargeback.  Money does not move and fees are not assessed during the retrieval process, which is why it is critical for merchants to respond before the “reply by” date.   
  5. Implement procedures to spot fraudulent chargebacks.  To minimize fraudulent charges being made by someone other than the card owner, merchants can decline transactions without a verified billing address and ask for the security code (CVV) found on the credit card. Cardholder verification is also recommended prior to shipping for large-ticket items.  Verification can include calling the customer to verify their details.

Chargebacks are a cost of doing business for merchants who accept card payments.  By taking steps to ensure customers are satisfied, merchants can reduce their exposure to the risks of chargebacks and their accompanying expenses.  Merchants who provide good communication, excellent customer service, and clearly stated transaction policies are taking proactive steps that can help them avoid the chargeback hassle.