Most sellers and service providers deal with chargebacks and refunds on a regular basis, and have the cash flow to cover them accordingly. But there may be times that outside factors, such as a natural disaster or global pandemic, interrupt this natural cycle. Your sellers or service providers might experience a period of fewer sales and higher refund requests, which could lead to a negative balance or the inability to return money to customers.
It's important to note that credit risk is different from fraud. While both result in losses, the biggest distinction is intent. Fraudsters don't intend to pay for goods or services. Instead, they pretend to be legitimate customers by using stolen cards and card numbers. Credit risk, on the other hand, tends to manifest as sellers or service providers who have every intention of fulfilling goods or services, but lack financial resources to withstand a downturn in demand, accumulate more refunds and chargebacks, and potentially exit the business - resulting in your platform owing money to customers.
For example, let's say you run a platform where event organizers can sell tickets. If the in-person events are canceled, the event organizers have to issue refunds to the customers. But, if the event organizers don't have enough money to complete the refunds, you - as the platform - could be responsible for making up that loss. As a result, you take on a large amount of credit risk on behalf of your sellers, exposing your platform to losses.
While there is no way to completely eliminate the credit risk of your sellers and service providers, this guide covers ways you can assess and manage your exposure.
How to assess your credit risk
The first step is to understand the risk profiles of the sellers and service providers on your platform or marketplace. The more information you gather, the better you can evaluate your own risk and keep your platform healthy. For example, based on financial activity, you could identify accounts that are more likely to face cash flow issues and have negative balances before they happen.
Risk indications can include one or more of these factors:
- Industries with longer delivery windows: Sellers or service providers who deliver goods and services weeks or months after a payment is processed, or over time with a subscription model, are riskier. The long delivery windows leave more room for something unexpected to happen, like a pandemic or supply chain issues, that could impact the ability to deliver goods and services.
- Elevated dispute activity: Disputes (or chargebacks) occur when customers question a payment with their card issuer (when they complete a purchase but never receive the item, for example). Accounts that have elevated dispute rates—above 0.75% is generally considered excessive—are riskier.
- Elevated refund rate: A substantial increase in refunds (for example, a 200% increase from the week or month before) can be a signal that sellers or service providers are unable to fulfill orders.
- Sharp volume decline: Accounts that have a significant decrease in volume compared to the previous week or month are more likely to experience cash flow issues and negative balances.
- Exposure to high-risk industries: Accounts that are exposed to certain industries like travel and events are particularly vulnerable to sudden changes—such as natural disasters or local health and safety issues—and may see an unexpected decline in sales or elevated refunds.
- Negative balance: Accounts with a negative balance won’t be able to process chargebacks and refunds, so the risk will fall to your platform.
How to manage credit risk
Once you have a list of your riskier accounts, you can start proactively managing your exposure. For sellers or service providers who seem more likely to pose risk to your business, you can change your payout schedule and encourage them to change the way they handle refunds and chargebacks. You can also re-evaluate your onboarding flow to get ahead of any new sellers or service providers with high-risk profiles who join your platform.
Here are five ways to manage the credit risk of your sellers or service providers:
- Change the way you assess risk during onboarding: Evaluate the risk of sellers or service providers during onboarding, before they even join your platform. Make sure you collect enough information about the goods and services being offered so you can determine if they fall within a high-risk category. For larger users, consider doing a more manual assessment, including a financial review. You can request proof of inventory and inquire about supply pipeline, delivery timeframe, refund policy, or expected gross payment volume. It’s also a good idea to monitor the account for the first few weeks to see how many disputes and refunds are processed.
- Defer or slow payouts for riskier accounts: For newer sellers or service providers, delay payouts (for example, hold payouts for a day or two) until you become familiar with their average volumes and chargeback rates. For goods and services that are not provided immediately, hold payouts until they are delivered. This reduces the likelihood of chargebacks and refunds because you can confirm that customers received what they paid for before releasing the funds.
- Review the way refunds are handled, and make appropriate adjustments: Some sellers or service providers may want to process refunds faster or automatically (for example, for charges that are more likely to be disputed) while others may want to process refunds more slowly to avoid negative balances. You can typically enable slower refunds by updating the interface or dashboard that buyers and sellers use to request refunds. Make sure your sellers or service providers communicate any changes to refund timelines to their customers.
- Reduce the impact of chargebacks and negative balances to your platform: If you are especially concerned about chargebacks, you can encourage your sellers or service providers to proactively cancel and refund charges that are likely to be disputed. While your seller or service provider would take a loss on the transaction, that may be better than getting a chargeback and providing a bad user experience. You can also require your sellers or service providers to pause recurring charges or subscriptions that are at high risk for chargebacks, which would give them more control over when to reinstate the subscription. For example, if they offer classes but the schedule is disrupted, they could pause the recurring fee for their customers.
- Support your sellers or service providers: Create resources to help your customers prepare for the unexpected. Examples include COVID-19 resources from Shopify and Xero, or Hurricane Harvey information for businesses from Mindbody. In addition, share best practices with your sellers or service providers to help them reduce the number of chargebacks, including:
- Don’t sell inventory you don’t already have.
- Clearly display your shipping terms, return policy, refund policy, and any money-back guarantees on your website.
- Have good customer support with defined SLAs.
- Establish an internal process for communicating any delays to customers.
- Provide tracking numbers to customers.
- Keep detailed copies of receipts, agreements, and proof of shipment. For digital goods or services, maintain access logs or documentation that ties usage back to customers.
How Stripe can help
Platforms and marketplaces of all sizes - from new startups to public companies like Shopify and Lyft - use Stripe Connect to onboard and verify users, accept online payments, and run technically sophisticated financial operations.
Stripe's technology can help you manage the risk of your sellers or service providers by:
Screening users: Stripe’s account verification process helps you onboard and verify sellers and service providers. Stripe leverages its experience from having verified millions of accounts already and uses proprietary systems to approve more users with less friction.
Surfacing dispute and refund information: The Stripe Dashboard provides a range of analytics and real-time charts about the performance of your platform or marketplace. Stripe Sigma allows you to quickly analyze your Stripe data by writing SQL queries directly in the Dashboard. With structured access to your data, you can identify which accounts process the most disputes and refunds and identify trends over time.
Enabling flexible payout schedules: Stripe offers a number of different payout schedule options that you can use depending on the risk profiles of your sellers or service providers. You can choose to automatically have funds paid out instantly or daily for established sellers or service providers, or set a custom payout schedule to slow or defer payouts to higher-risk accounts.
Offering loss liability coverage: Stripe can help manage user risk so you don't have to worry about credit losses. If your sellers or service providers have Standard Connect accounts, you aren't responsible for the cost of Stripe fees, refunds, and chargebacks.
For more information on how Stripe can help platforms and marketplaces, read our docs.