Chargebacks: The ultimate guide

Chargebacks sound like refunds but they’re very different. Find out what they really are and how to manage them effectively.

The restrictions caused by COVID-19 have impacted every industry. Overall, this has meant a much lower rate of transactions, especially for payments at point of sale.

On the other side, customer behavior and purchasing volume through delivery companies, online marketplaces and platforms, online retailers and electronic stores have increased. With more online orders, it’s inevitable that refunds will be higher than usual. In fact, online purchases are three times more likely to be returned than in-store purchases.

In most cases when buying goods and services, customers can ask for a refund directly from the business within a refund policy. Sometimes though, the refund request may not be accepted by the business, for a variety of reasons such as a damaged product being returned when stated otherwise. If this differing of opinion occurs, the customer may request a chargeback.

Chargebacks sound like refunds but they’re very different. With a chargeback, the customer contacts the bank directly to take money from the account of the business concerned. As opposed to a refund where the customer only deals with the business.

Any fees associated with chargebacks are significantly higher than the refund ones too, which makes chargebacks quite expensive to process.

In this article we’ll help you understand how to handle chargebacks, disputes, and the risk of fraud you may face. And, provide a clearer picture of why chargebacks are a good thing for you and your customers in the long run, if you handle them properly.

What are chargebacks?

A chargeback is a transaction reversal initiated by a customer’s bank after the shopper disagrees with a charge on his or her card. It is meant as a consumer protection mechanism against fraudulent activity committed by illegitimate merchants or individuals.

For merchants: For customers:
Chargebacks can be frustrating and a threat to your revenue Chargebacks represent a shield between you and dishonest merchants

How do chargebacks work?

The chargeback process can be very different for each payment provider. On a basic level, once a customer requests a chargeback, and the bank confirms that it’s a valid request, funds are then removed from the merchant’s account and returned to the customer. In a bit more detail, it usually looks like this:

  1. The cardholder files a chargeback
  2. The issuer reviews / assigns a reason code to the case
  3. The issuer investigates and initiates the chargeback
  4. The scheme receives the chargeback and forwards to the acquirer
  5. The acquirer receives the chargeback and funds are taken from the merchant’s account
  6. The merchant reviews the chargeback and provides defense document if they choose to challenge
  7. The merchant decision is forwarded through the scheme to the issuer
  8. The issuer reviews the defense document and makes final decision to accept or decline it
  9. If the issuer accepts the defense document, funds are returned to the merchant

How to avoid chargebacks

During this unpredictable time, you can reflect and focus on smaller details in your business that can impact the amount of chargebacks you may face. Creating a solid strategy now will help you avoid chargebacks and further solidify your business for when normal service resumes.

Go above and beyond: Your customer experience needs to be outstanding.

  • Make sure goods reach the customer before the latest expected delivery date.
  • Refund customers proactively if goods/services cannot be provided by the expected delivery date.
  • Set realistic expectations for delivery of goods/services (both if you have logistical delays from impact of crisis, or if you have increased volume).

Act quickly: Focus on premium customer service.

  • Practice good, prompt customer service for customers who are looking for information and updates about their purchases.
  • Offer reasonable alternatives for future services, which could be vouchers or credits.
  • Avoid charging no-show fees, or other relevant fees, for not utilising services booked as a result of COVID-19 travel restrictions.
  • Refund as quickly as possible when the customer requests a refund.
  • Reply to a request for information from the issuer as soon as you can to prevent it from becoming a chargeback.
  • Refund a transaction as soon as you receive a notification of fraud from the issuer to prevent it from becoming a chargeback.

Stay alert: Not all fraud is the same.

  • Keep a close eye on legitimate transactions reported as fraud, also known as friendly fraud.
  • Make sure you’re closely monitoring transactions.
  • Review and update your risk settings to minimise the possibility of fraud.
  • Choose a payments partner with a long track record of dealing with fraud.

Tips for managing chargebacks

After you receive a chargeback you can either accept it, or defend against it. If you’re experiencing an increased volume of requests, here are some best practices we recommend.

Review continuously

Keep an eye on what chargebacks you’re receiving. It’s an ongoing reviewal process and only when you have strong evidence that the transaction was legitimate should you dispute.

Example situations when you would accept a chargeback

Late refund Value too low
The cardholder has returned the goods and you (the merchant) failed to refund the customer within the agreed timeframe. The transaction value is too low. This is when the value of the chargeback won’t outweigh the chargeback handling fees.

Refund reserve

Explore the possibility of setting up a refund reserve to ensure there’s a sufficient balance if you wish to send refunds automatically.

Fraud types

Ensure you have optimal risk processes in place to combat payment fraud such as refund fraud and account takeovers.

Market changes

Both Mastercard and Visa are suspending their Excessive Chargeback Compliance programs for the next four months for applicable merchants. Under these programs, the schemes set thresholds to define “normal” chargeback levels for businesses. COVID-19 might hamper some merchants’ ability to deliver their products or services, which could increase the number of chargebacks they experience.

By suspending their programs it means these merchants will not be flagged in the case of an elevated chargeback-to-sales ratio and, correspondingly, no financial penalties will apply during this time.

These programs are risk-monitoring solutions and have no impact on chargebacks. Merchants still can, and do, receive chargebacks from these schemes, but they won't be considered "risky" if their chargeback to transaction volume ratio grows.

Here to help whenever you need

With the continued uncertainty surrounding the coronavirus outbreak, it’s a good time to be proactive and take steps to prevent and fight disputes. We are one of the payment industry’s leading experts in risk management and we are here to help.

For more information, we have in-depth documentation on Risk Management in our docs environment, and if you’re an Adyen customer you can head over to the updates section in the Adyen Customer Area.

Disclaimer: This article should be used only for guidance purposes, and should not be taken as definitive advice. You should always consult your risk management consultant or payment service provider. If you’re an Adyen customer, we’re always here to help, so do reach out to us if you have any questions.

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