Why are Chargebacks harmful to your business?

As previously explained in Chargebacks: Understand How They Work, chargebacks involve a time-consuming and costly process. Disputes can take up to ten weeks to be solved and, throughout the different phases, merchants are presented with added costs that can go up to three times the sales value. To avoid losing the funds, merchants need to gather sufficient evidence, interact with several stakeholders, and take action in each phase.

Ideally, you want to keep your chargeback rate at 0.00% and never have to worry about it anymore. But when it comes to fraud, things can slip out of your control.

If the chargeback rate exceeds the card network’s standard threshold — 0.9% for Visa and 1.5% for Mastercard—merchants can expect to enter a monitoring program. These merchants should be prepared to face adverse penalties that heavily impact their business:

• Higher fees. Besides the chargeback fees charged by processors and acquirers for each chargeback, merchants can be penalized on all processing fees. Merchants who have a history of excessive chargebacks can be categorized by card networks into a high-risk Merchant Category Code (MCC). Merchants with high-risk MCC are stuck working with acquirers and processors who charge higher fees for all transactions.
• Excessive Fines. By entering these monitor programs, merchants become subject to severe fines. For Visa and Mastercard, fines can go from $1,000 to $200,000 depending on the business chargeback rate and the time it takes to lower and keep it below the threshold.
• Lose the ability to challenge chargebacks. If a merchant has been proven to continuously incur chargebacks, the card network might suspend that merchant’s ability to fight any further chargeback until a decrease in the chargeback rate is verified.
• Inability to accept card payments. If the chargeback rate remains above the card network’s threshold for several months, merchants may be forbidden to operate under a particular card network or have their accounts shut down by the acquiring bank. Mastercard created the MATCH (Member Alert to Control High-Risk Merchants) list to include businesses that have one or more merchant accounts terminated by their acquiring banks. It serves as a reference tool for financial institutions since any business listed here has a high potential of risk.

The true cost of losing a chargeback can surpass two or three times the transaction value if you consider all the expenses associated, namely:

• Transaction fee costs set by the card network;
• Operational costs of picking, packing, shipping, and delivering;
• Marketing and sales acquisition costs;
• Chargeback fees—which can vary from $20 to $100 depending on your acquiring bank.

It is estimated that every dollar lost to chargebacks costs merchants about $2.40. This means that for a $100 sale, you might lose $240 if it turns into a chargeback.

On top of the severe consequences related to the cost and time that chargeback disputes generate, the merchant’s reputation can also become significantly damaged within the market and the payment industry.

What generates chargebacks?

There are multiple reasons for chargebacks to happen, going from a real fraud to an unethical customer intention. Reasons for chargebacks generally fall into four categories:

• Actual fraud. A fraudster used legitimate cardholder’s information to do a purchase. The real cardholder, seeing this charge on their statement, files a chargeback request against the charges on their debit/credit card.
• Merchant error or negligence. The merchant either never shipped out the order, shipped out an item that was broken or different than described, or made a billing mistake by overcharging the customer without rectifying the situation. When the authorized cardholder fails to receive the item they paid for, they file a chargeback on that transaction.
• Friendly fraud. An industry term to describe a type of fraud that happens when the cardholder is, at the same time, the fraudster. Friendly fraud can come in two forms:

1. When the cardholder unintentionally commits fraud by disputing a legitimate purchase. This is usually the result of confusion or misunderstanding, making customers believe they have been charged for a transaction they did not approve of. The most common reason comes from not recognizing the purchase because it could have been done by a relative, or because the customer forgot they’ve made the purchase.
2. When authorized cardholders dispute legitimate charges to their credit cards. The most common reasons include: (1) they want to avoid paying for the order in question, (2) the customer is impatient to receive the order or the delivery schedule was not correctly followed/perceived, (3) the return process seems too complex and inconvenient, or (4) the customer has remorses regarding the purchase.

Although actual fraud is still the main cause for filing chargebacks, the growth of e-commerce during the COVID-19 pandemic made room for the outburst of friendly fraud. Merchants, including the largest digital sellers such as Apple, Microsoft, Amazon, and Google have had 80% of their fraud transaction losses associated with friendly fraud.

The extent of friendly fraud highlights the importance of responding to chargebacks and recovering revenue that was unfairly lost.

How can you avoid Chargebacks?

To prevent chargebacks effectively, merchants should focus on multiple methods. Prevention requires an ever-evolving and continuous effort to avoid chargebacks and streamline the dispute resolution process. So, how can you achieve that?

Apply efficient customer service and transparent policies.

Encouraging customers to turn directly to you to solve a problem related with an order is one of the best ways to keep them from filing a chargeback. By communicating with the customer before a dispute is processed as a chargeback, you have the opportunity to tackle the situation and process a refund or issue a credit so that a chargeback never occurs.

Additionally, it is important to assure that the merchant’s policy is transparent and understandable for users. Billing information, such as payment descriptions, should be clearly identifiable to them, so there’s no room for misunderstandings.

Use fraud prevention tools.

Use technology to track customer behaviors and ensure that the purchases are legitimate:

• Enable Address Verification Service (AVS). The technology verifies if the billing address submitted by the customer at the checkout matches the cardholder’s billing address on record at the issuing bank.
• Add 3D Secure 2.0, an extra layer of security for online payments. After the user has filled in the username and password they will be requested further information for stronger authentication often called 2-factor authentication. It can be a one-time passcode (OTP) sent via SMS, or a numeric code generated by a soft-token that is valid for less than 1 minute. With 3DS payments, the liability for fraudulent chargebacks shifts from the merchant to the card issuer.
• Verify the IP Address. This verification can be done using the IP address to determine the geolocation of the user and compare it with the card issuing country through the BIN (Bank Identification Number). It’s also possible to determine if a consumer is using several distinct IP addresses in a certain timeframe (minutes/hours/days), or a VPN, which increases the possibility of fraud.
• Keep PCI-DSS Compliance across all point-of-sale systems. The official standard of PCI provides security measures to prevent card fraud and unauthorized transactions by checking the card’s validity and suspicious account behavior.

Accept non-reversible payment methods.

As the name suggests, there are payment methods in which fund reversal is not possible. Cryptocurrency or online bank transfers are some examples that can be particularly beneficial for high-risk use cases. It might favor your business, if you consider enabling only non-reversible payment methods to users who have a history of several chargebacks and who have, therefore, a higher probability of being a fraudster.

Examples of non-reversible payment methods: Multibanco (Portugal), Giropay (Germany), P24 (Poland), Sofort, Trustly, Boleto Bancário (Brazil), and Paysafecard.

Although they’re not irreversible, some payment methods offer member protection programs that can help you prevent chargeback occurrence. This is the case of Alipay (China). The company compensates buyers if their accounts were used for unauthorized transactions. The only consequence for merchants is losing revenue.

Assess your business and create risk rules.

Every day that you’re not responding to a dispute, you’re missing the chance of avoiding funds loss. That’s why you should keep track of your transaction status when it comes to understanding if they’ve originated a retrieval, chargeback, or arbitration process.

Different acquirers or payment providers have different ways of providing this information. You’ll have to know how this information is sent to you so you can properly record the company’s finances.

With Switch Reconciliation, we cut out that burden from you by matching your transactions to the subsequent settlement batches. We provide you standardized information about settlements, agreements, and disputes in the same dashboard where you keep track of your transactions. When it comes to chargebacks, you just need to focus on the actions you’ll take to tackle them.

But you can also be a step ahead of the issue, by studying your market and industry and knowing your users’ behavior. By gathering this information you can begin implementing actions that will help you prevent the chance of chargebacks. Through the Switch Risk API, you can create risk rules that best fit your context. Flag, block and allow transactions, and also enable 3DS, based on the country, amount, card type, currency, among other relevant parameters.

When it comes to chargeback prevention, it’s important to be proactive. The more proactive steps you can take to stop chargebacks, the less you will experience them, minimizing the chance of becoming a high-risk merchant in the eyes of the market and the payment industry.

Reach out to us to know how the Switch Reconciliation API can help you manage disputes.

Additionally, you can get an overview of the steps involved in chargebacks through our Chargeback Process Explained infographic.

Discover the full version of this infographic here.