What is a chargeback: risks, dispute and how to prevent it?

A chargeback occurs when a payment is reversed following a customer's disputes a payment on their account statement.

For example: A customer might have received a damaged product or the merchant billed them twice due to a processing error. In such situations, a customer can initiate a chargeback with their bank for credit or debit card transactions.

If the chargeback request is approved, the customer is refunded the full transaction amount. However, if the merchant disputes the chargeback claim, they have a chance to defend it.

While both chargebacks and refunds involve returning funds, they are fundamentally different processes. Customers usually request a refund directly from the merchant, following the merchant's refund policy. However, sometimes the merchant may decline the refund, perhaps claiming the product wasn't damaged or the delivery was on time. In these cases, customers might pursue a chargeback instead.

With a chargeback, the customer contacts their bank, not the business, to initiate a payment reversal. The chargeback process involves more steps and can be time-consuming compared to a refund. Additionally, the fees associated with chargebacks are typically higher than those for refunds.

The chargeback process can vary depending on the payment provider, but generally, it involves a few key steps. First, the customer initiates a chargeback request with their bank, which then verifies the claim. Once validated, funds are withdrawn from the merchant's account and returned to the customer. The merchant then has the option to dispute the chargeback.

For a more detailed breakdown, the process generally unfolds as follows:

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:

Fraud

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

Consumer disputes

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.

Processing errors

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

Authorization

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:

Make returns easy

• Refund as quickly as possible when the customer requests one

• Have a clear returns policy

• Provide your email address and phone number on your website and emails so that the customer can easily contact you

Get the goods to the customer on time

• Set a realistic delivery date. If there are delays, let the customer know as soon as possible.

• Refund customers proactively if you can't provide the goods/services by the expected delivery date

• Track your goods to monitor their delivery date. Ask the customer to sign for the package on delivery for extra security.

Avoid any miscommunication

• Ensure the payment descriptor of your bank account is clear and accurate

• Respond to any customer questions quickly

• Alert your customers if a product is out of stock as soon as possible

• Provide detailed product descriptions on your website

Prevent fraud

• Use authentication tools like Address Verification Service (AVS), card security codes (CVV), and 3D Secure 2

• Make sure your risk system can identify customers who regularly file a chargeback and could be committing friendly fraud

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.

When is it worth disputing a chargeback? 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:

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:

• evidence of their previous undisputed purchases

• proof of delivery at the cardholder’s address

• or any contact they’ve had with your customer service team

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.