Mention “chargeback” to most online (and even brick-and-mortar) merchants, and you’ll strike a nerve. While an unavoidable part of doing business, chargebacks have become increasingly common—and are challenging for sellers to contest.
Sarah is a Marketing Manager at Clearsale and has been with the company since 2012. During that time, she has developed deep knowledge about fraud prevention. She brings extensive expertise in planning, marketing, go-to-market strategy and sales experience, thanks to a background that spans financial planning, controlling and analysis. She previously spent 5 years with Proctor & Gamble, and she holds bachelor and master degrees in Business with great distinction from a top Brazilian business school.
But how do chargebacks happen in the first place, and how can merchants avoid them?
What Is a Credit Card Chargeback?
Simply, a credit card chargeback is a sale that’s refunded to a customer—a reversal of transferred funds. After a customer dispute, which may occur for any number of reasons (we outline some in the next section), the card-issuing bank debits the merchant’s account.
Chargebacks can take anywhere from six weeks to six months to be processed, depending on how quickly the consumer notices and reports the fraudulent activity and how quickly the issuing bank responds.
It’s important for all businesses to know their chargeback rates. They can be calculated in one of two ways:
- Cash Basis: Divide the total chargebacks received in the current month by the total transactions generated in the current month. Most card networks utilize some variation on this basic formula. For example, if you received a chargeback in September, it would be counted in your September chargeback rate.
- Accrual Basis: Divide the total chargebacks in a given month by the transactions that occurred during that month. For example, if you received a chargeback in September on a sale made in July, it would be counted in your July chargeback rate. This means your monthly chargeback rates will need to be updated continually.
(MasterCard calculates chargeback rates slightly differently: by dividing the number of first chargebacks filed in the current month by the number of transactions made in the previous month.)
While it’s difficult to make your chargeback rate zero, it’s important to keep it as low as possible. A good rule of thumb is to keep the ratio lower than 1%. However, some businesses are successful in getting their chargeback rates to under 0.3%.
On the other hand, the closer you get to 1% could signal it’s time to take preventative action. Higher than 1% almost definitely means trouble.
Why Do Businesses Experience High Chargeback Rates?
There are myriad reasons a chargeback is initiated. (MasterCard alone offers more than 35 credit card chargeback reason codes.). Some of them are founded (defective goods, multiple charges for one item), while others are fraud-based (a false claim that goods weren’t delivered, a fraud investigation initiated by a card issuer).
Other common chargeback reasons include customers who:
- Had their credit card information stolen and used without consent
- Received the wrong item
- Were billed an incorrect amount
- Were dissatisfied with the quality of the product or service
- Didn’t receive credit for a returned item
Can High Chargeback Rates Jeopardize a Business?
Honest merchants want to prevent chargebacks while keeping customers happy. High chargeback rates can not only damage your reputation, they can have serious consequences to your bottom line and business operations.
Specifically, an overabundance of chargebacks can result in:
- A freeze of your credit card account
- The possibility of that account being terminated—preventing your business from processing any transactions until you find a new provider
- Investigations and even potential criminal charges
Moreover, merchants are typically responsible for the cost of each chargeback and the related fees, which can exceed $75 per dispute. Not costly enough? Add in the expense of replacing and reshipping lost or stolen goods, and the dollars quickly add up.
In fact, chargebacks cost merchants nearly $11.2 billion in lost revenue during 2015.
Fighting a possibly incorrect chargeback isn’t always an option, either. When it comes to consumer disputes, the merchant is essentially considered guilty until proven innocent. It’s a very high bar to pass, and as a result, it opens the door for consumers to potentially abuse the system.
Tips for Reducing Fraud—and Chargebacks
With 70% of fraud being committed through chargebacks, there’s ample financial incentive for online retailers to implement security measures. And the two best ways to reduce chargebacks is by education(understanding chargebacks and what causes them) and prevention (implementing security measures and verification procedures).
We’ve talked already about what chargebacks are; now, let’s explore a few of the ways to reduce risk. An ounce of prevention now is truly worth a pound of cure later.
To help prevent fraudulent chargebacks, you should:
- Require CVC2 (Mastercard), CVV2 (Visa), or CID (American Express) numbers for each transaction. These numbers are printed on the card, rather than embossed or stored in the magnetic strip. As a result, requiring these numbers can minimize card-not-present fraud, since fraudsters will generally need to have the card in hand to have this information.
- Review an unsettled transactions log daily, specifically looking for names, credit cards, and IP addresses. If you see a customer has entered numerous credit card numbers—or maybe slightly varying the numbers each time—from the same IP address, fraud is likely.
- Carefully communicate your business name that customers will see on their statements. This helps prevent chargebacks caused by confusion over a DBA or parent company name that may appear on a credit card statement.
- Limit declined transactions by locking a user out after a predetermined number of incorrect entries. (Fraudsters may try numerous credit card numbers in rapid succession in the hopes of finding one that works.) Bonus: Your credit card company might be charging you for each declined transaction, so this can limit those fees as well.
Keep in mind that a 0% chargeback ration isn’t necessarily the goal. You don’t want to set fraud prevention measures that are so strict nothing gets by, and you certainly don’t want to turn away legitimate customers. Weigh the benefits of fraud prevention against its costs, and make sure whatever approach you settle on strikes the right balance between protecting your profits and enabling maximum sales.
Chargebacks—fraudulent or otherwise—are a challenging problem for merchants today. Excessive credit card chargebacks can cost you time, money, and energy. Take the time now to arm your security system, so when—not if—the time comes to safeguard yourself and your business, you’ll be ready.