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Payments 101 - What are Chargebacks?

No matter where your business is based, or the goods you trade, chargebacks are a frustrating, expensive and complex part of doing business. Unfortunately, if you accept payments online, you will almost certainly experience them – it’s only a matter of time. 

To give you a bit of history: Chargebacks originated in the United States with The Fair Credit Billing Act of 1974, which gave consumers greater protections against not just fraud, but merchant-related issues too, by allowing them to dispute transactions. Chargebacks occur when consumers flag the transaction with their issuing bank to contest the validity of a purchase.

Today, the term chargeback generally refers to this specific consumer-initiated purchase dispute process.

In an ideal world, consumers would always reach out to the merchant if a purchase is suspected to be fraudulent or if a product arrives differently than described. Some situations cannot be handled this way because the merchant is uncontactable, or refuses to issue a refund (due to policy, lack of evidence of fraud, etc.). But, in many situations where it is possible for consumers to talk to merchants, they don’t. Instead, some consumers skip the merchant step and go directly to their issuing bank to initiate a chargeback when they’re unsatisfied with a purchase. 


Who’s involved in a chargeback? 

The main parties involved in a typical chargeback or transaction dispute are: 

  • Cardholder – the consumer who has been issued a card (typically from a bank). Referred to by merchants as ‘customers’.
  • Issuing Bank – this is the cardholder's bank 
  • Merchant – this is the company or individual who sold goods or services to the cardholder 
  • Acquiring Bank – this is the merchant's bank 
  • Card Association – these are companies like Visa and Mastercard who oversee the chargeback process 

What is the process of a chargeback?

To put it plainly, there are many types of chargebacks that can be initiated by a consumer. These are represented by specific reason codes – which can vary by card scheme. However, for the purposes of this article, we have boiled down the complicated process of chargebacks into a simplified overview. Note that, in real life, the actual chargeback experience may vary: 

  1. A customer is unable to resolve a problem with a merchant and initiates a transaction dispute by contacting their issuing bank by phone, email or online. 
  2. The issuing bank then forwards the disputed transaction through to the specific card scheme and onto the acquiring bank to obtain the funds from the merchant. 
  3. The acquiring bank then sends the details of the disputed transaction to the merchant. At the same time, the acquiring bank deducts the transaction amount from the merchant's account. 
  4. The merchant then has two options. One: they can accept the chargeback, weighing if they have enough information to fight the dispute against the cost and benefits. Or two: they can submit compelling evidence to counter the chargeback – known as a representment. 
  5. If compelling evidence is sent back to the acquiring bank, then a decision is made on the validity of the evidence presented. If the acquiring bank reviews the evidence and believes the chargeback is invalid the information is sent to the issuing bank. 
  6. Upon receipt of the compelling evidence, the issuing bank will then decide to either stand by the original decision or accept the new evidence. 

Once a decision has been made, merchants feel of the brunt of the chargeback, as fees can range anywhere from $13 to $100. Statistics estimate that for every dollar of the original purchase amount, it can end up costing merchants $2.40. 

Sadly, some merchants choose to accept chargebacks and fees because they do not have the time or the resource to effectively manage the multi-stage dispute process. 

However, merchants should be wary of this approach because it can negatively impact their standing with card associations like Visa and Mastercard – who set percentage limits on the number of disputed and fraud transactions allowed to be claimed as chargebacks. If a merchant incurs too many chargebacks, then card associations can potentially deny your ability to process electronic payments.   

 

Solutions for merchants 

In no uncertain terms, chargebacks are typically part of day-to-day business for online merchants. For many, the time and monetary investment required for battling transaction disputes adds up fast – impacting the efficacy and viability of maintaining a business for small merchants. 

Want to stop chargebacks before they happen? Contact Ethoca today and find out how!