What are chargebacks and how to prevent them

Chargebacks were introduced to offer consumers an easy way to dispute suspicious transactions and to protect them from fraud. But for businesses, chargebacks can put revenue at risk, especially as friendly fraud becomes more common.

Although chargebacks are a part of doing business (and a good sign that your risk management strategy isn't overly strict), there are ways to reduce them.

This article will explore what chargebacks are, how the process works, and ways you can prevent and respond to them.

A chargeback is when a payment is reversed after a customer disputes a charge on their account statement.

For example:

The customer might have received a damaged product. Or maybe the merchant made a processing error and accidentally charged the customer twice. In these cases, a customer can file a chargeback with their bank for transactions made on credit or debit cards.

Once approved, the customer receives the transaction amount back in full. But if the merchant disagrees with the chargeback claim, they have the chance to defend it.

Although chargebacks and refunds both involve the return of funds, they’re very different.

Mostly, customers can ask for a refund directly from the merchant within their refund policy. But sometimes, the merchant might reject the refund request.

Maybe the merchant claims the product wasn’t damaged on arrival or believes the package was actually delivered on time. If there’s a difference in opinion, the customer may request a chargeback.

With a chargeback, the customer contacts the bank (not the business) to reverse the payment. The chargeback process takes longer and involves a few more stages than a refund. And any fees associated with a chargeback are significantly higher than a refund.

The chargeback process differs depending on the payment provider. On a basic level, a customer requests a chargeback and the bank validates it. Funds are taken from the merchant’s account and then returned to the customer. After this happens, the merchant may dispute the chargeback.

In a bit more detail, it usually looks like this:

If the issuer declines the merchant’s defense, they can argue against it. This is called a second chargeback, which is usually refused.

If the issuer declines the second chargeback, you can go through a third round, called arbitration. Arbitration is often not advised as the fees are particularly high (up to $500 on top of the disputed amount).

When the issuer approves the chargeback from the cardholder, they assign a reason code. Each card scheme has a different set of reason codes, but they all fall into one of the following groups:

The cardholder claims they didn’t make or authorize the transaction.

The product wasn’t as described or didn’t arrive by the expected delivery date. Or the cardholder was informed the payment wasn’t processed.

Some of the payment information was incorrect. This could include information like the amount, currency, or account number.

The payment couldn’t be authorized, or the authorization was declined.

Chargebacks can cost businesses both the purchase amount as well as additional fees. Banks and card networks may also penalize you if your chargeback ratio (the percentage of chargebacks of your transactions) becomes too high.

Preventing chargebacks is more important than defending them. Even if you win the chargeback defense, it’ll still count against your chargeback ratio.

Although you can't avoid chargebacks altogether, there are ways to lower the amount. Here’s what to focus on:

After a chargeback is initiated, you’ll receive a Notification of Chargeback (NoC). From this point, you can choose to defend the chargeback within 14-40 days (see the exact time frame per card scheme).

Start by reviewing the case and the reason code to understand why you received the chargeback and if it’s worth disputing.

Build a case with as much evidence as possible. Try to collect all your interactions with the customer to help disprove the chargeback claim.

For instance, if the cardholder claims they didn’t take part in a transaction, you could provide:

Some payment providers, like Adyen, will automatically defend chargebacks if the case is straightforward. For example, if you’ve already refunded a transaction before the cardholder filed for the chargeback, Adyen’s auto-defense feature will defend it with no action needed on your part.

Once you’ve submitted the defense, the card issuer will either accept or decline it.

See how disputing a chargeback works in practice. Learn how you can defend a chargeback in the Adyen platform: