Chargeback fraud — the basics
What businesses need to know about the chargeback maze, fraud disputes and policy abuse
Chargeback fraud affects all types and sizes of business. It’s a growing problem.
Originating in the 1970’s, chargebacks are a consumer protection tool from the early days of credit cards. In essence, they’re supposed to be a last resort for consumers to recover money from a merchant via the consumer’s bank when a purchase goes wrong. While this process is in place to protect consumers against fraud, it can also be abused by bad actors.
When a merchant suspects that the chargeback process was abused, they can choose to fight it. Chargeback Policy Abuse can proactively be prevented. — Dispute.com
As a business owner, you are aware, probably highly aware, that completing a transaction doesn’t mean the end of your relationship with a customer. From the moment a customer decides to make a purchase, a series of actions gets triggered, each creating an opportunity to generate enthusiasm and affinity for your business — or to derail the transaction and lose that customer for good. Even though converting a customer is widely regarded to be the “finish line”, the truth is that anything from a less-than-secure website to hazy delivery details or unreachable customer service can lead to the dark side of a completed payment:
It’s safe to assume that every business owner would prefer to hold on to as much revenue as possible. However, even the best-laid conversion funnels sometimes lead to a situation where a customer wants their money back after completing a purchase. Below, we’ll take a more detailed look at everything surrounding chargebacks: what is a chargeback, how do chargebacks work, what causes them and how business owners can proactively work to prevent them.
What is a chargeback?
Let’s start by thinking about the meaning of “chargeback”. A chargeback is a reversal of funds following a debit or credit card purchase, resulting in either a credit card chargeback or a chargeback on a debit card. This is set in motion when the customer files a dispute over the charge with their bank or credit card provider. Chargebacks are almost always initiated by customers, but businesses can request them as well (although this doesn’t happen very often).
The good news about chargeback disputes: the global chargeback-to-transaction ratio tends to decrease year after year, meaning that there are fewer bank chargebacks each year compared with the overall number of transactions. This can be attributed to multiple factors that businesses are investing in, most of which we’ll cover below.
The bad news: chargebacks are still a widespread and costly problem which is entangled with business fraud more broadly. According to a study released by Juniper Research, e-commerce businesses were projected to lose roughly US$20 billion in 2021 due to fraud, an 18% increase over the US$17.5 billion lost in 2020. And according to The True Cost of Fraud report by LexisNexis, businesses end up paying US$3.75 for every US$1.00 in chargebacks.
Chargeback vs refund
Now we understand what “chargeback” means, let’s consider it in relation to a refund. A refund is when the business returns funds to the customer, whereas a chargeback is when the customer’s bank or credit card provider reverses the charge and pulls back the funds from the business. In both cases, funds are returned to the customer. The difference between a chargeback and a refund is primarily a matter of which party initiates the reversal of funds, but there are a few other key differences:
- Who is actively involved?
With chargebacks, the issuing bank drives the action, staying in contact with the customer and the business throughout the process. With refunds, the customer usually deals directly with the business, which will then initiate the reversal of funds from their end. - Who controls the money?
With refunds, the business is in control of the disputed funds, whereas with chargebacks, the customer’s bank is in the driving seat. Refunds involve the business telling their payment processor to return funds to the customer. Until they initiate this transfer, no money is moved anywhere. However, with a chargeback, the customer’s bank will usually make a start and pull the funds in question from the business’s account. It will then hold on to them while it sorts out whether the chargeback request is valid. - How long does it take?
Not counting the time that it takes for the customer and business to communicate with each other and decide that, in fact, a refund is warranted (this could take anywhere from a brief conversation to several weeks of emails), the refund process itself usually takes three to seven working days. Chargebacks, however, can take anywhere from a few weeks to several months, especially if the business contests the disputed charge.
Common reasons for chargebacks
To make an actionable plan for mitigating how many chargebacks your business incurs, it’s important to understand the various reasons behind why they happen. Here are a few of the most common scenarios:
- Legitimate fraud
In essence, this is the reason why chargebacks exist in the first place. The idea behind them is to give consumers a tool to reverse transactions that show up on their account due to fraudulent activity — and legitimate fraud still constitutes a large portion of chargebacks. - Friendly fraud
This sounds so much nicer than it really is. “Friendly fraud” is the umbrella term for a variety of chargeback reasons that don’t have anything to do with legitimate fraud. Technically, cardholders are only supposed to dispute a charge and trigger a chargeback for a limited number of reasons. In reality, many people simply don’t put too much thought into whether or not they should dispute a charge. Instead, they use it as a quick fix for a wide range of situations. Here are a few common examples. - They don’t recognise the charge.
If someone looks at their credit card statement and sees a charge that they don’t remember incurring, they might opt to dispute it and receive a chargeback. Perhaps they made the purchase and forgot about it, maybe it’s a recurring fee for a subscription that they forgot they had, or it could be that the name of the business wasn’t clear on the card statement. If a transaction doesn’t look familiar to a cardholder, there’s a chance that they’ll dispute it. - There are delivery problems.
If an item never arrived or is taking longer than expected, the customer might assume that it’s got lost and request a chargeback. This is especially likely if the customer was never given delivery details or a tracking number, or if they couldn’t contact the business easily to enquire about the status of their order. - They want to avoid the returns process.
Often, chargebacks are used as an easy way to get out of processing a return. If a customer is unhappy with an item that they purchased, found the business’s returns policy to be opaque or cumbersome, or wanted to return an item but has already missed the allotted window of time, they could initiate a chargeback. - Correcting clerical mistakes
Mistakes happen and chargebacks are one mechanism that can be used to correct them. If a customer was charged more than once or if they’re still being billed for a cancelled subscription, they might file a dispute with their bank or credit card company to rectify the errors, which could result in a credit card chargeback. These types of chargebacks are more frequent when the charge comes from a business that doesn’t have any customer service readily available. If the customer can’t request a refund from the company easily, they might consider a chargeback to be their best recourse.
Confused? Perturbed? Click here for the quickest, pertinent Chargeback Glossary of Terms.
