Chargebacks 101: Understanding the 4 Chargeback Types

An online merchant’s ability to process credit card transactions is a critical part of doing business. But while these transactions are a merchant’s bread and butter, they also increase the risk of costly chargebacks.

Chargebacks are transaction reversals that credit card issuers originally created as a way for consumers to dispute and reverse unauthorized transactions charged to their credit cards. While consumer protection is a good thing, high rates of chargebacks can be problematic for merchants, resulting in higher processing fees, wasted time that must be spent managing chargebacks, and even the suspension or cancellation of a merchant’s account.

Compounding on this is the fact that consumers today often file chargebacks unnecessarily – either to commit outright fraud against the merchant or out of a misunderstanding with the merchant. To prevent excessive chargebacks and minimize their effects, merchants must understand the four general reasons for those chargebacks.

How Credit Card Issuers Categorize Chargebacks

Credit card issuers assign every chargeback a numeric code (known as a “reason code”) that describes why the chargeback was requested by the consumer. Although Visa, American Express and Mastercard all have their own reason codes, each code fits into four general categories:

  • Criminal fraud
  • Consumer disputes
  • Authorization issues
  • Processing errors

These reason codes help online merchants analyze the most common reasons for — and, sometimes, patterns to — chargebacks. For example, merchants may discover their warehouse routinely sends customers the wrong product. Or maybe the billing department isn’t processing cancellation requests for recurrent transactions in timely manner. Reason codes and their respective categories give e-commerce merchants unique insight into problematic transactions.

1. Criminal Fraud

When card holders discover a criminal accessed their credit card data and used it to make fraudulent purchases, the customer may file a chargeback to recoup their funds.

2. Consumer Disputes

Some consumer disputes are legitimate complaints about an order that doesn’t go as planned. In other cases, the customer is making an honest mistake. For example, if the customer doesn’t recognize the merchant’s name on their credit card statement or forgot about a recurring credit card charge, the customer may file a chargeback — even though in both situations, the transaction may have been perfectly legitimate. These situations are referred to as “friendly fraud.”

Sometimes, however, customers file chargebacks with the dishonest intention of ordering a product, receiving a refund on the order and still keeping the product. This situation is considered “chargeback fraud.”

It’s difficult, if not impossible, for merchants to determine which customers are making an honest chargeback claim and which ones are trying to defraud the merchant. In the end, the result is the same: lost merchandise, lost revenue and an increased chargeback ratio.

3. Authorization Issues

These chargebacks occur when merchants don’t obtain the proper authorization for a transaction, don’t submit a valid authorization approval or don’t submit a verifiable authorization.

4. Processing Errors

Sometimes, card holders don’t dispute they made a purchase. What they do dispute is whether the merchant held up their end of the deal.

The most common types of processing errors include:

  • A card holder authorized a transaction but didn’t receive the goods or services from the merchant.
  • The consumer cancels a recurring transaction, but the merchant doesn’t process the cancellation.
  • A transaction charge was processed more than once.
  • A customer returns an order, but the merchant doesn’t refund the credit card.
  • The transaction amount the merchant submits differs from the amount the card holder agreed to.

Avoiding the Damaging Effects of Chargebacks

Chargebacks may seem like an inevitable part of doing business, but there are steps merchants can take to avoid them, including:

  1. Clearly state return and exchange policies on product pages, checkout screens and order confirmations.
  2. Use delivery confirmation for every shipment, and use signature confirmation for expensive orders.
  3. Use the same business name when possible on websites, order confirmations, customer communication and credit card statements. If company names vary, ensure customers know what name to expect on their credit card bills.
  4. Keep all customer correspondence and transactional records until after the chargeback window has passed.
  1. Stay current on evolving chargeback codes and trends to learn which transactions may be at risk.

Basing a chargeback management strategy on reason codes alone isn’t enough to prevent revenue loss and safeguard a merchant’s credit card processing account. Fraudsters are always looking for ways to exploit weaknesses in the system and launch fraud attacks against e-commerce retailers. And disputing every chargeback wastes valuable time and manpower hours that could be better spent growing your business. So how can smart merchants reduce their odds of being a victim?

Consider ClearSale’s customized approach to fraud protection. It not only protects online retailers against the increased frequency of card-not-present and friendly fraud, but it also offers 100% guaranteed protection that covers businesses against fraudulent transactions that result in a chargeback. Contact a ClearSale analyst today to learn how our guarantee can help you identify trends and areas of weakness, evaluate and prevent chargeback claims, and improve customer satisfaction.

ClearSale Fraud Protection Buyers Guide