Chargebacks – the basics: What they are and how businesses can prevent them

Radar
Radar

Accept payments online, in person, and around the world with a payments solution built for any business—from scaling startups to global enterprises.

Learn more 
  1. Introduction
  2. What is a chargeback?
  3. Chargeback vs refund
  4. Common reasons for chargebacks
  5. How do chargebacks work?
  6. How much do chargebacks cost businesses?
  7. Ways to prevent chargebacks
  8. How to dispute a chargeback

As a business owner, you are probably highly aware that your relationship with a customer doesn't end once they've completed their transaction. From the moment a customer decides to make a purchase, a series of actions takes place, each offering 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: chargebacks.

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's in this article?

  • What is a chargeback?
  • Chargeback vs refund
  • Common reasons for chargebacks
  • How do chargebacks work?
  • How much do chargebacks cost businesses?
  • Ways to prevent chargebacks
  • How to dispute a chargeback

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.

How do chargebacks work?

Chargebacks occur only once the initial transaction has ended: the payment is processed, the funds are transferred to the business's account and the charge appears on the customer's credit card statement.

This is when the chargeback process begins. Let's take a look at how chargebacks work:

1. The customer files a dispute.

Once the customer sees a charge on their account statement that they believe to be fraudulent, they file a dispute against the charge with the bank or financial institution that issued the credit card used for the purchase (in other words, the issuing bank).

2. The issuing bank initiates the chargeback.

When the customer disputes a charge, the issuing bank then begins the chargeback process.

3. The business has the chance to refute the chargeback.

As soon as a customer requests a chargeback, their bank will contact the business's bank and notify them that the chargeback has been requested. At this point, the business has the opportunity to provide any evidence that refutes the customer's claim that the charge is illegitimate.

4. The bank makes a decision.

The issuing bank will review evidence on both sides of the chargeback dispute and render a decision about whether to proceed. At this point, if the business declined to provide any evidence to support the validity of the charge, the issuing bank will generally approve the customer's request for a chargeback.

5. If the issuing bank rules in the business's favour...

If the cardholder's bank decides that the charge was valid and declines to proceed with the chargeback, then the funds are not returned to the customer. If the issuer had already credited the cardholder's account for the disputed amount before the charge was investigated and the charge is then found to be valid, those funds or the credit will once again be removed from the cardholder's account.

6. If the issuing bank rules in the customer's favour...

If the bank determines that the customer has legitimate grounds to request the chargeback, the funds are withdrawn from the business's account and credited back to the customer.

7. Arbitration may follow the decision in a chargeback dispute.

If the bank decides in favour of the business and the customer still wants to fight for the chargeback, the customer has an option to pursue arbitration. This takes the chargeback dispute to the credit card company itself. It's effectively an appeals process for the issuing bank's decision. The credit card companies – Visa, American Express, Mastercard, Discover etc. – have the final say in a chargeback dispute.

How much do chargebacks cost businesses?

Fees associated with bank chargebacks vary depending on which payment processing provider you use, regardless of whether it's a credit card chargeback or a chargeback on a debit card. Stripe charges a US$15 fee for each chargeback dispute. Other providers' fees can be as high as US$50 or even US$100. Obviously, the goal is to have as few chargeback disputes as possible. However, they do happen from time to time, so it's important to find out what your payment processing provider charges.

Ways to prevent chargebacks

Let's be proactive about this issue. Even the most vigilant businesses are going to end up with some chargebacks, but there are steps that you can take to minimise their frequency. We have an article that goes deeper into the important steps that you can take to reduce chargebacks. But briefly, here are a few key points to bear in mind:

  • Prioritise security for credit card payments to avoid credit card chargebacks.
  • Make returns as easy as possible.
  • Manage delivery expectations.
  • Be available to your customers.
  • Make sure that your real company name is displayed on credit card statements.

How to dispute a chargeback

Even if you do everything possible to prevent bank chargebacks from happening, they inevitably will. When chargebacks happen, it's important to have a plan of action in place for vetting the authenticity of fraud claims and moving forwards, no matter the outcome. Here's an overview of what disputing a chargeback claim looks like, to see how chargebacks work in more detail:

  • Determine the legitimacy of the chargeback dispute.
    If you are notified about a chargeback, you'll first need to determine whether it's being prompted by an actual incident of fraud or if a customer-service issue is behind it.

  • If the charge is genuinely fraudulent...
    If your initial investigation into the charge reveals a true case of fraud, you should let the customer's issuing bank know that you won't be contesting the chargeback and that they should return the funds to the customer. You'll also need to let your payment processing provider know about the fraud and look into whether it was an isolated occurrence or a bigger issue affecting other transactions.

  • If it's friendly fraud...
    If you look into the issue and determine that no actual fraud occurred, addressing the bank chargeback with the customer ultimately depends on why they initiated it in the first place. Regardless, you'll probably want to dispute the chargeback, which involves taking a few actions:

    • Contact the customer.
      Many chargeback situations can be handled by contacting the customer directly, expressing a desire to resolve whatever issue prompted them to file for a chargeback and listening to what they have to say. In most cases, it's worth trying to engage the customer in a conversation and come to a resolution on your own, before the dispute process begins and they're potentially charged back. You might end up refunding them anyway, but even if that's the outcome, a refund is better for your business than a chargeback.
    • Provide evidence to refute the chargeback.
      If pursuing a resolution with the customer doesn't work and you're confident that no real fraud took place, you should provide evidence to that effect to try and prevent the money from being charged back. Receipts, confirmation numbers, delivery information – all of this can help affirm the legitimacy of the transaction. Your payment processing provider will likely be the one to communicate with the customer's issuing bank, so they can hand over any evidence. Then, you'll wait for the issuing bank to come to a decision about whether to approve the chargeback.

Dealing with chargebacks isn't anyone's favourite part of doing business, but taking both proactive and defensive steps against them can minimise revenue loss through money being charged back, as well as disruption to the more enjoyable aspects of running your business. For a more detailed guide to preventing chargebacks, read more here. And to explore how Stripe Radar helps businesses fight chargebacks, click here to learn more.

Ready to get started?

Create an account and start accepting payments – no contracts or banking details required. Or, contact us to design a custom package for your business.