E-commerce chargebacks 101: What they are, why they happen and how to prevent them

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  1. Introduction
  2. What are e-commerce chargebacks?
  3. How do e-commerce chargebacks work?
  4. Why do e-commerce chargebacks happen?
  5. How do e-commerce chargebacks affect businesses?
  6. How to prevent e-commerce chargebacks

The online marketplace is booming, but this surge in digital shopping brings with it the growing challenge of e-commerce chargebacks.

Not all chargebacks are fraudulent, but as a mechanism, chargebacks are particularly vulnerable to fraud and end up creating a significant influx of fraudulent activity. LexisNexis estimates that every US$1 lost to fraud costs US$4.24 for businesses that don't integrate customer experience operations with fraud prevention strategies – but that number falls to US$3.66 for businesses that do.

Understanding and addressing the issue of chargebacks is an important concern for e-commerce businesses. Not only do chargebacks result in lost sales and added fees, but a high chargeback rate can also strain relationships with payment processors and sometimes lead to account termination. In addition, chargebacks can damage consumer trust. Taking steps to minimise chargebacks is an investment in the long-term health and sustainability of an online business. Below are insights and strategies to help businesses protect themselves against the costly – and potentially debilitating – effects of chargebacks.

What's in this article?

  • What are e-commerce chargebacks?
  • How do e-commerce chargebacks work?
  • Why do e-commerce chargebacks happen?
  • How do e-commerce chargebacks affect businesses?
  • How to prevent e-commerce chargebacks

What are e-commerce chargebacks?

E-commerce chargebacks are a process in which a customer disputes a charge made by an online business and seeks to reverse the transaction. Chargebacks are meant to be a form of consumer protection, but sometimes they are misused – this is called chargeback fraud – or occur as a result of genuine misunderstandings.

How do e-commerce chargebacks work?

E-commerce chargebacks consist of a series of steps involving the customer, the business, and the card issuer or bank. Here's how the process works:

  • Initiation: The customer contacts their credit card issuer or bank to dispute a transaction, and provides a reason for the chargeback, such as: the charge was the result of unauthorised use; they never received the item that the charge was related to; or the product that they received didn't match how it was described. Further below, we'll cover the different reasons why chargebacks happen.

  • Review by issuer: The card issuer or bank reviews the claim. If it believes that it might be valid, it credits the disputed amount back to the customer temporarily, and initiates the chargeback process.

  • Notification to business: The card issuer or bank notifies the business of the chargeback and may be asked to provide evidence to counter the customer's claim. This could include delivery information, communication logs or transaction records. This part of the process is known as representment.

  • Business response: The business submits any evidence that it has to counter the customer's claim. This step is important for the business because it allows it to defend the legitimacy of the transaction.

  • Final decision: The card issuer reviews the evidence from the customer and the business and makes a final decision. If the card issuer decides to uphold the chargeback, the temporary credit that was sent to the customer becomes permanent. If the card issuer decides to deny the chargeback, the temporary credit is reversed and the customer is charged again.

  • Potential additional fees: If the card issuer decides to uphold the chargeback, the business usually has to pay a chargeback fee and might face other penalties depending on the number of chargebacks it receives.

Why do e-commerce chargebacks happen?

E-commerce chargebacks are a double-edged sword. While they are designed to protect consumers from fraudulent transactions and unsatisfactory experiences, they can also harm businesses if customers misuse them or if they occur too frequently. Chargebacks can happen in different circumstances and for different reasons, such as:

  • Fraudulent transactions
    This is when a fraudulent actor gains unauthorised access to someone's credit card information and uses it to make purchases. When the legitimate cardholder discovers these unauthorised transactions, they file for a chargeback to reclaim the stolen funds. Businesses need to have strong security measures to detect and prevent fraudulent transactions – more on that below.

  • Credit card not present
    By default, e-commerce transactions occur without a physical card, which makes it difficult to verify whether the person making the purchase is the actual cardholder – and leads to higher instances of fraud. For businesses, implementing additional verification steps, such as requiring customers to type in CVV codes during a purchase, can help mitigate this.

  • Item not received
    Sometimes, a customer does not receive the product they ordered due to delivery errors or other logistical issues. If the customer thinks that the business is unresponsive or that it's failing to solve the issue in a timely manner, they may file a chargeback – which is why it's important for businesses to provide reliable delivery and communicate with customers about any delays or issues.

  • Item delivered is not as described
    When a customer receives the product they ordered and realises that it's significantly different from what they saw online, they may file a chargeback, especially if the business's return policy is unclear or unsatisfactory. To minimise the chances of this happening, businesses should ensure that product descriptions and images are accurate and clear.

  • Duplicate charges
    Sometimes, technical glitches or errors that occur during payment processing can result in duplicate charges for a single purchase. When a customer realises that they have been charged multiple times, they may file a chargeback to recover the funds from the duplicate charge(s). Businesses can prevent this by monitoring and correcting billing errors promptly.

  • Processing errors
    Processing errors include mistakes that occur during the transaction process, such as when a business charges a customer the wrong amount. A customer who notices an incorrect charge on their statement might file a chargeback to correct the problem. This emphasises how important it is for businesses to prioritise meticulous transaction processing and rectify errors promptly.

  • Customer dissatisfaction
    If a customer is unhappy with a product or thinks that the level of service they received was inadequate, they might seek a refund through the business. But if the business does not resolve the issue to the customer's satisfaction, the customer may file a chargeback as a last resort. Offering exceptional customer service and a fair return policy is key to preventing these types of chargeback.

  • Friendly fraud
    Friendly fraud is when a customer intentionally abuses the chargeback process by making a false claim that a transaction was unauthorised or the product wasn't received, even though they received and kept the item. This is a form of theft and hurts businesses. Implementing strong verification processes and maintaining detailed records can help businesses in disputing such cases.

How do e-commerce chargebacks affect businesses?

In theory, chargebacks serve as a consumer protection mechanism, but they can also be used to exploit businesses. In both cases, chargebacks can pose serious problems and costs for businesses. Here's a detailed look at the different ways in which e-commerce chargebacks can affect businesses:

  • Financial losses
    When a customer files a chargeback, the business loses not only the revenue from the sale, but also the product (if it has already been dispatched). In addition, card networks usually charge businesses for each chargeback, a fee that ranges from US$20 to US$100 or more. For example, if a business sells a laptop for US$1,000 and faces a chargeback, it might lose both the laptop and an additional fee. This is when it's helpful to work with the right payment processing provider. Stripe, for example, offers chargeback protection, which covers the disputed amount plus fees.

  • Operational costs
    Dealing with chargebacks requires time and resources. If they are not working with a payment provider that handles chargebacks, businesses must allocate staff to handle chargeback disputes, gather evidence and communicate with banks and payment processors. This can be particularly difficult for small businesses with limited resources.

  • Increased processing fees
    If a business experiences a high number of chargebacks relative to its sales volume, payment processors may categorise the business as high-risk. This can lead to increased transaction fees or stricter terms. For instance, a small online store that experiences a sudden influx of chargebacks might find that its payment processor increases transaction fees from 2.9% to 4.5%.

  • Loss of payment processing
    In extreme cases, if a business consistently exceeds a certain chargeback ratio, payment processors might terminate their service altogether. This would mean that the business would no longer be able to accept credit card payments, which is often necessary for e-commerce operations.

  • Damage to reputation
    Frequent chargebacks can damage a business's reputation. Customers may perceive the business as unreliable, or even fraudulent. In the age of online reviews and social media, a negative review can spread quickly and deter potential customers from making purchases. For example, if an online clothing store frequently sends out items that don't match the description, resulting in numerous chargebacks, potential customers might read about these experiences in reviews and choose to shop elsewhere.

  • Loss of merchandise and restocking
    In cases where the product is returned, the business may incur additional costs associated with restocking and refurbishing the product for resale. If the product is perishable or time-sensitive (such as a seasonal item), the business might not be able to resell the item.

  • Cash flow issues
    Chargebacks can create cash flow problems, especially for small businesses. When a customer initiates a chargeback, the funds are immediately withdrawn from the business's account. This can be a problem if the business is relying on that revenue for operations. For larger e-commerce businesses, marketplaces and platforms, this could make it difficult or impossible to forecast revenue reliably, which can significantly hinder growth planning.

While some chargebacks are unavoidable, many aren't. Businesses should do everything in their power to minimise chargebacks through excellent customer service, clear communication, accurate product descriptions and effective fraud prevention measures. These steps allow businesses to protect their revenue, reputation and relationships with payment processors. Below is more information about these prevention measures.

How to prevent e-commerce chargebacks

For online businesses, preventing e-commerce chargebacks is important for safeguarding their reputation and financial health. These businesses can implement a combination of tactics to mitigate the risk of chargebacks. Here's a detailed look at some of these actions:

  • Write clear and accurate product descriptions
    Ensure that all product descriptions on your website are comprehensive and precise. Include high-resolution images from different angles to give customers as much information as possible. This can help to reduce chargebacks that occur when a customer receives a product that looks different from the one that they thought they ordered.

  • Create and publicise transparent policies
    Be upfront about your delivery, return, refund and cancellation policies. Make sure that these policies are easily accessible on your website and are written in clear language that limits the chances of misunderstandings and subsequent chargebacks.

  • Provide exceptional customer service
    Provide prompt and effective customer support through multiple channels (email, phone, chat etc.). Meeting customer enquiries and complaints with high-quality customer service can prevent customers from filing a chargeback in the first place.

  • Offer regular order confirmation and updates
    Send order confirmations immediately after a customer makes a purchase and keep the customer informed about the shipping and delivery status. This provides customers with a timeline and helps to manage expectations, which can reduce the likelihood of chargebacks.

  • Use a secure payment gateway
    Employ reputable and secure payment gateway and processing providers to handle transactions. This adds an extra layer of security and often comes with built-in fraud detection tools such as Stripe Radar.

  • Employ an address verification service (AVS)
    Implement an AVS to compare the billing address that the customer provides with the address registered with the credit card company. This helps to identify potentially fraudulent transactions.

  • Require card verification value (CVV) checks
    Requiring customers to input the CVV code during a transaction can reduce fraud because it ensures that the person making the purchase has the physical card. This is especially important for online transactions.

  • Use 3D Secure authentication
    Use additional security measures such as Verified by Visa or Mastercard SecureCode to authenticate the customer's identity. These technologies require the customer to enter a password or a code before the transaction can be authorised.

  • Engage in regular monitoring of transactions
    Keep an eye on transaction patterns and watch for suspicious activity such as multiple orders from the same IP address or several orders placed within a short time. This can indicate fraudulent activity, a common cause of chargebacks.

  • Use chargeback management tools
    Consider using third-party services that specialise in chargeback management, such as Stripe's Chargeback Protection. Chargeback Protection safeguards your revenue by shielding your sales from fraudulent disputes, thereby averting potential losses. Regardless of the legitimacy of the dispute, Stripe Chargeback Protection ensures that you are reimbursed for the disputed sum and waives any associated fees.

Chargeback Protection is built to serve all businesses that use Stripe. It covers both digital and physical goods and applies to transactions of all sizes, anywhere in the world. These tools can help you identify potential chargebacks before they happen, manage disputes efficiently and offer valuable insights for improving your prevention strategies. To learn more, go here.

The content in this article is for general information and education purposes only and should not be construed as legal or tax advice. Stripe does not warrant or guarantee the accurateness, completeness, adequacy, or currency of the information in the article. You should seek the advice of a competent attorney or accountant licensed to practice in your jurisdiction for advice on your particular situation.

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