As a business owner, you are probably well aware that your relationship with a customer doesn’t end after they’ve completed their transaction. From the minute 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 as the “finish line,” the truth is that anything from a less-than-secure website to foggy shipping details to 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, but even the best-laid conversion funnels sometimes lead to a situation in which a customer wants their money back after completing a purchase. Below, we dig into everything about chargebacks: what they are, how they 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?
A chargeback is a reversal of funds following a debit or credit card purchase, 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 often).
The good news about chargebacks: The global chargeback-to-transaction ratio tends to decrease year after year, meaning there are fewer chargebacks each year compared to the overall number of transactions. This can be attributed to multiple factors that businesses are investing in—most of which we cover below.
The bad news: Chargebacks are still a widespread and costly problem that’s entangled with business fraud more broadly. According to a study released by Juniper Research, ecommerce businesses were projected to lose roughly $20 billion in 2021 due to fraud, an 18% increase over the $17.5 billion lost in 2020. And according to The True Cost of Fraud report by LexisNexis, businesses end up paying $3.75 for every $1.00 in chargebacks.
Chargeback vs. 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, who 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 driver’s seat. Refunds involve the business telling their payment processor to return funds to the customer. Until they initiate this transfer, no money moves anywhere. But with a chargeback, the customer’s bank will usually go ahead and pull the funds in question from the business’s account and hold on to them while they sort out whether the chargeback request is valid.
- How long does it take?
Not counting the time it takes for the customer and business to communicate and reach a decision that, in fact, a refund is warranted (this could take anywhere from one brief conversation to several weeks of emails), the refund process itself usually takes three to seven business 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
In order to make an actionable plan for mitigating how many chargebacks your business incurs, it’s important to understand the various reasons why they happen. Here are a few of the most common scenarios:
In essence, this is the reason why chargebacks exist in the first place. The inciting 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.
This sounds so much nicer than it is. “Friendly fraud” is the umbrella term for a variety of chargeback reasons that don’t have 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 and instead use it as a quick fix for a wide range of situations. Here are a few common examples:
- They don’t recognize the charge.
If someone looks at their credit card statement and sees a charge they don’t remember incurring, they might opt to dispute it and get a chargeback. Maybe they made the purchase and forgot, perhaps it’s a recurring fee for a subscription they forgot they had, or maybe the business’s name didn’t appear clearly on the card statement. If a transaction doesn’t look familiar to a cardholder, there’s a chance they’ll dispute it.
- There are delivery problems.
If an item never arrived or is taking longer than expected, the customer might assume it’s lost and request a chargeback. This is especially likely if the customer was never given shipping details or a tracking number, or they couldn’t easily contact the business to inquire about the status of their order.
- They want to avoid the return process.
Often, chargebacks are used like an easy “get out of processing a return” card. If a customer is unhappy with an item they purchased, found the business’s returns policy to be opaque or cumbersome, or wanted to return an item but were already outside the allotted window of time, they could initiate a chargeback.
- They don’t recognize the charge.
Correcting clerical mistakes:
Mistakes happen, and chargebacks are one mechanism for correcting them. If a customer was charged more than once, or if they’re still being billed for a canceled subscription, they might file a dispute with their bank or credit card company to rectify the errors. These types of chargebacks are more frequent when the charge comes from a business without readily available customer service. If the customer can’t easily request a refund from the company, they might consider a chargeback to be their best recourse.
How do chargebacks work?
Chargebacks occur only after the initial transaction ends: 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:
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 (aka, 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 reach out to the business’s bank and give them a heads-up 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 charge’s validity, the issuing bank generally will approve the customer’s request for a chargeback.
5. If the issuing bank rules in the business’s favor...
If the cardholder’s bank decides 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 credit will be removed again from the cardholder’s account.
6. If the issuing bank rules in the customer’s favor...
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.
If the bank decides in favor of the business, and the customer still wants to fight for the chargeback, the customer has the option of pursuing arbitration. This takes the issue 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 word in a chargeback dispute.
How much do chargebacks cost businesses?
Fees associated with chargebacks vary depending on which payment processing provider you use. Stripe charges a $15 fee for each chargeback. Other providers’ fees can reach $50 or even $100. Obviously, the goal is to have as few chargebacks as possible, but 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 get proactive about this issue. Even the most vigilant businesses are going to end up with some chargebacks, but there are steps you can take to minimize their frequency. We have an article that goes deeper into the important steps you can take to reduce chargebacks, but briefly, here are a few key points to keep in mind:
- Prioritize security for credit card payments.
- Make returns as easy as possible.
- Manage shipping expectations.
- Be available to your customers.
- Make sure your real company name shows up on credit card statements.
How to dispute a chargeback
Even if you do everything possible to prevent chargebacks from happening, they inevitably will. And when that happens, it’s important to have a plan of action for vetting the authenticity of fraud claims and moving forward, no matter the outcome. Here’s an overview of what disputing a chargeback claim looks like:
Determine the legitimacy of the dispute.
If you are notified about a chargeback, first you’ll want to determine whether it’s being prompted by actual fraud or if a customer service issue is behind it.
If the charge is genuinely fraudulent...
If your initial investigation into the charge reveals true 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 want 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 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 doing a few things:
- Reach out to 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. 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. Receipts, confirmation numbers, shipping 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.
- Reach out to the customer.
Dealing with chargebacks isn’t anyone’s favorite part of doing business, but taking both proactive and defensive steps against them can minimize revenue loss and disruption to the more enjoyable aspects of running your business. For a more thorough guide to preventing chargebacks, read more here. And to explore how Stripe Radar helps businesses fight chargebacks, click here to learn more.