How Do Chargebacks Work In Credit Card Processing?

Chargebacks occur when a cardholder disputes a transaction with their issuing bank and requests a refund or reversal. Though chargebacks are a legitimate part of the credit card fraud and dispute resolution process, they can significantly impact merchants by generating fees, damaging customer relationships, and harming reputations. For businesses processing a high volume of credit card payments, minimizing chargebacks is crucial to reducing costs and improving the customer experience.

There are several common reasons why chargebacks arise in the first place. At times, a cardholder may dispute a charge illegitimately, but other times the merchant may be at legitimate fault due to issues with authorization, processing errors, or unfavorable policies. Regardless of responsibility, each chargeback results in fees charged to the merchant by their acquiring bank or payment processor. These fees, typically $15-$20 or more per chargeback, can quickly add up and hurt a business’s bottom line, especially for those processing millions of transactions each year.

Beyond direct costs, managing chargebacks also demands time and resources. Merchants have to research each dispute, determine whether it was justified, and prepare a response with evidence to contest unjustified chargebacks. This requires work by staff members, diverting their focus from core business operations. Excessive chargebacks may even prompt acquiring banks and payment partners to increase fees across the board, impose penalties, or in severe cases temporarily suspend a merchant’s ability to accept credit card payments.

Reasons for chargebacks

There are several common reasons why chargebacks originate. Perhaps the most straightforward is the fraudulent use of a card number, in which an unauthorized party charges purchases to a victim’s account. In these cases, the merchant is typically not at fault, though they may face fees and hassle contesting the chargeback.

Processing errors represent another major category, including issues like incorrectly keyed card numbers, duplicate charges, overcharges, and expirations that were missed. Merchants frequently bear responsibility for these types of errors, as they demonstrate a lack of proper procedures or oversight. Even small mistakes can provoke chargebacks and damage trust.

customer order cancellations also commonly lead to chargebacks, especially if a retailer’s policies are unclear or inflexible. If a cardholder cancels an order within the merchant’s stated window for refunds but is still denied, they may dispute the charge with their issuer and credit card network. Without a liberal cancellation policy and staff trained on its procedures, chargebacks in this area are more likely.

In some cases, the same transaction could be processed multiple times due to issues with a merchant’s payment gateway or system. When a cardholder notices duplicate charges, they will likely initiate a chargeback for one of the transactions. Then the merchant has to determine which were legitimate and which were duplicates, incurring additional cost and effort.

Impacts of chargebacks

High chargeback rates create significant costs and consequences for merchants. Directly, each chargeback results in fees, typically $15-$20 or more per transaction, charged by the acquirer or payment processor. These fees add up quickly for businesses processing millions of transactions per year, especially those with chargebacks rising above industry standards. The fees alone can amount to a substantial loss, diverting revenue away from core business operations.

Beyond the direct costs, staff time must be spent researching each chargeback dispute and determining whether it was valid before addressing it. This includes reviewing transactions, communications, shipping details, policies, and in some cases contacting the cardholder directly. The time required for chargeback management can be quite extensive, taxing existing employees and resources.

Damage to reputation and trust is also at stake with excessive chargebacks. High rates signal to customers, partners, and payment networks that there may be issues with a merchant’s practices, procedures, or reliability. This can significantly hurt customer loyalty, make it harder to attract new clients, and in severe cases put business partnerships and payment processing at risk.

Acquirers and payment gateways may decide to increase fees across the board on merchants with chargeback rates above the norm. This includes not only chargeback fees but also percentage-based transaction, monthly, and other costs. The increases aim to offset the additional risk but end up costing merchants more in the long run. In extreme situations, a merchant may face temporary suspension of their ability to accept credit/debit cards as payment until chargeback activity is lowered.

No business wants to experience these consequences, so minimizing chargebacks should remain an ongoing priority. By validating customers, optimizing policies, providing effective training, and closely monitoring metrics, merchants can maintain healthy chargeback ratios, stronger financials, superior service, and trusted relationships with all parties involved in the payments process. With proactive management, the impacts of chargebacks can be avoided altogether.

Ways to minimize chargebacks

To minimize chargebacks, merchants must first gain a clear perspective on the sources of disputes in their business. Carefully tracking chargeback rates, reasons, and volumes by category can shed light on specific areas for improvement. If fraud seems to drive chargebacks most frequently, extra verification steps may help. If processing errors dominate, procedure audits and staff re-training could reduce issues.

Cardholder address verification is one of the most effective fraud prevention methods. Requiring cardholder addresses, verifying them against issuer records and declining mismatches can avoid unauthorized charges upfront. While this does not catch all fraud, it can eliminate a substantial portion of fraudulent disputes.

For recurring billing, clear terms and conditions should be in place requiring additional authorizations for future charges. Without proper recurring authorization, any chargeback for the cancellation of a recurring payment will likely be justified. Staff should be trained on reviewing authorizations before re-charging a customer.

Liberal cancellation and refund policies, when handled properly, actually reduce chargebacks rather than increase them. Merchants need only be transparent about window durations, conditions, and procedures for obtaining refunds or credits. As long as policies are fair, clearly stated, and consistently followed by staff, customers will understand their options and the limits around them.

Salient training for all customer-facing employees is essential. Whether assisting customers over the phone, via email, or in person, staff should understand how to properly process refunds, identify issues leading to chargebacks, and resolve them promptly using the approved policies and procedures. Blind spots here lead to preventable errors and chargebacks.

Finally, constant monitoring helps identify new sources of chargebacks and never-ending opportunities for improvement. Even the most effective fraud prevention and error mitigation strategies require ongoing assessment based on metrics. Chargeback numbers, reasons, volumes from various teams/locations and more should be reviewed regularly at both an aggregate and granular level. With consistent tracking, chargeback management becomes faster, easier, and more predictive over time.

Conclusion

 In conclusion, chargebacks represent a significant challenge for merchants to mitigate in the payments process. Though unavoidable to some extent, excessive chargebacks can damage reputations, hurt customer relationships, increase costs and hurt business profitability. Through proactive management, chargeback risks can be minimized greatly.

Understanding the reasons why chargebacks originate, such as fraud, processing errors, policy confusion, and more, provides insights into targeted areas for improvement. Employing strategies to validate customers, optimize policies, provide comprehensive staff training, and closely monitor metrics then helps prevent issues’ root causes. Over time, as with any process, chargeback management also becomes faster, easier, and more cost-effective.

Though direct costs may be unavoidable for some number of chargebacks, the indirect and long-term consequences of high chargeback rates are far more damaging. Reputational harm, acquirer fees, loss of customer trust, and staff burnout will accelerate if chargebacks rise above the industry standard. For these reasons, merchants should make chargeback reduction a top priority.

By gaining a deeper perspective into not just chargeback numbers but also the nature of disputes, root causes of problems, and team/location-specific issues, effective solutions can be developed. Partnerships with payments experts can also help gain outside perspectives, validate strategies, and benchmark against peers. With consistent oversight and progress over time, chargeback activity can be trimmed significantly while still delivering a superior customer experience.