A merchant's guide to chargebacks: Protecting your revenue and reducing disputes

For any business owner, e-commerce manager or financial professional, ‘chargeback’ is a word that brings up a feeling of dread. It represents a forced reversal of funds that not only hits your bottom line directly but also carries a ripple effect of hidden costs and potential long-term damage. 

A chargeback is a consumer protection mechanism: a transaction reversal initiated by a cardholder’s bank on behalf of their customer. The chargeback exists to protect consumers from unauthorised transactions, non-delivery of goods or services not rendered as promised. While it’s important for consumer trust, chargebacks can be a burden for merchants. 

We’re here to unpack the chargeback ecosystem from a merchant’s perspective, and most importantly, the proactive strategies you can implement to prevent and manage them effectively.

Chargeback vs. refund: An important distinction

It’s crucial to understand the fundamental difference between a chargeback and a refund, as this is a common point of confusion for many merchants.

There’s a difference between a chargeback and a refund: 

A refund is a direct transaction initiated by the merchant. When a customer contacts you about a problem or wants to return an item, and you agree to return the funds according to your established return or cancellation policy, that’s a refund. It’s a consensual agreement between you and the customer, processed directly through your payment gateway or point-of-sale system. 

A chargeback is a more formal, complex process involving multiple parties beyond just you and your customer. It bypasses your customer service channels completely. When a cardholder initiates a chargeback, they contact their issuing bank, the acquiring bank (your bank) and the respective payment network. 

Unlike a refund, a chargeback is typically accompanied by a punitive chargeback fee imposed by your acquiring bank and can negatively impact your merchant account standing.

The anatomy of a dispute: Common reasons for chargebacks

It’s important to understand why chargebacks happen, to try and prevent them. They generally fall into four main categories:

1. True fraud: This is perhaps the most straightforward category. It occurs when a cardholder genuinely didn't authorise the transaction - for example, if their card was stolen, the card number was compromised or their identity was used without consent.

2. Merchant error: These chargebacks result from mistakes on the merchant's side - such as duplicate charges for the same transaction, incorrect billing amounts, use of the wrong currency, or processing errors that lead to overcharging.

3. Customer dispute: In these cases, the customer has a legitimate issue with the product or service received. This could involve goods not received (even if shipped), faulty goods or services, merchandise significantly not as described or a failure to provide a promised service. The customer genuinely believes they did not receive what they paid for or that it was substandard.

4. "Friendly fraud" (or chargeback abuse): This is arguably the most frustrating category for merchants. Friendly fraud occurs when a customer disputes a legitimate charge, either intentionally or unintentionally. This might happen if they forget a purchase, don't recognise a descriptor on their bank statement or if a family member made an authorised purchase without their knowledge. More nefariously, it can involve customers deliberately making a purchase with the intent to claim a chargeback to get goods or services for free – a form of digital shoplifting.

The chargeback journey: The step-by-step process

When a chargeback occurs, it usually follows a defined, multi-step process:

1. Step 1: Initiation: The cardholder notices an unfamiliar or disputed transaction on their statement and contacts their issuing bank to dispute the charge.

2. Step 2: Provisional credit: The issuing bank sometimes grants the cardholder a provisional credit for the disputed amount while they investigate the claim.

3. Step 3: The acquiring bank is notified: The dispute information travels through the respective payment network (e.g., Visa, Mastercard) from the issuing bank to the merchant's acquiring bank (or payment processor).

4. Step 4: The merchant is debited: Your acquiring bank will typically debit your merchant account for the full amount of the disputed transaction, plus an additional, non-refundable chargeback fee.

5. Step 5: Evidence review (representment): You, the merchant, are then notified of the chargeback. You'll be given a limited chargeback period (usually around 10 days, depending on the card scheme and reason code) to gather and submit compelling evidence to your acquiring bank to refute the cardholder's claim. This process is known as representment. If your evidence is strong enough, the funds may be returned to you. If not, or if you fail to respond within the given timeframe, the chargeback stands.

6. Step 6: Pre-arbitration and arbitration: If either party disagrees with the outcome, the case can move to pre-arbitration, allowing submission of additional evidence. If still unresolved, it may escalate to arbitration, where the card network issues a final decision. Arbitration involves significant fees (around 600 EUR for Visa) and is typically reserved for exceptional cases.

The financial sting: The true cost to your business

A chargeback can mean more than just the loss of a single transaction, it can also cause: 

• Merchandise loss: In cases of true fraud or friendly fraud, you often lose both the revenue from the sale and the physical product or value of the service rendered.

• Fees and penalties: Every chargeback incurs a non-refundable chargeback fee levied by your acquiring bank, which can range from £10 to £50 per dispute. These fees apply whether you win or lose the chargeback.

• Operational costs: The time and resources spent by your staff investigating the dispute, gathering evidence, and preparing your representment package contribute significantly to the overall cost.

• Risk to your merchant account: Your chargeback ratio (the number of chargebacks compared to your total transactions) is closely monitored by acquiring banks and payment networks. A high ratio can lead to increased processing fees, additional reserves held by your bank or in severe cases, the termination of your merchant account agreement, making it difficult to process payments in the future.

• Arbitration fee: There may be an arbitration fee involved, for Visa this is 600 EUR. 

Proactive protection: How to prevent chargebacks

The best defence against chargebacks is a prevention strategy. When you know the common causes, you can implement measures to reduce your exposure: 

• Excellent customer service: Make it incredibly easy for customers to contact you first for refunds, exchanges or complaints. A readily available phone number, email or live chat can often resolve issues before they escalate to a chargeback.

• Clear policies: Ensure your shipping, return, refund and cancellation policies are transparent, easy to find on your website and unambiguous. Explicitly state delivery timelines and return conditions.

• Accurate product descriptions: Avoid ambiguity. Ensure product descriptions, images, and service specifications are precise and manage customer expectations effectively to prevent dissatisfaction and "not as described" disputes.

• Recognisable billing descriptors: Make sure your business name appears clearly on customers' bank statements. A vague or unfamiliar descriptor is a common trigger for customers to dispute a charge they simply don't recognise.

• Use fraud protection technology: Implement robust tools to verify transactions. This includes AVS (Address Verification Service) and CVV (Card Verification Value) checks, which help confirm the cardholder's identity. For e-commerce, 3D Secure (e.g., Verified by Visa, Mastercard Identity Check) provides an additional layer of authentication, shifting liability away from the merchant for certain types of fraud.

• Leverage prevention tools: Modern collaborative solutions like Ethoca Alerts or Verifi provide real-time notifications from the issuer alert system when a cardholder disputes a charge with their bank. These alerts allow you to issue a refund and proactively resolve the issue, avoiding the formal chargeback process and its associated fees entirely.

Conclusion: Taking control of disputes

Chargebacks are an unavoidable part of operating in the digital economy, but they’re not uncontrollable. By understanding chargebacks from your perspective as a merchant, the common reasons behind them, engaging in the dispute resolution process and implementing prevention strategies, you can really reduce their impact. 

By taking control of your chargebacks, you can protect your immediate revenue and the long-term health and reputation of your business.