How to prevent chargebacks

In an ideal online business transaction, your customer will be satisfied with the goods or services they have paid for and received, and you will have notched up another successful sale. However, if the customer is not happy with the transaction and wants their money back, what happens then? Dealing with chargebacks is not quite as straightforward as it might seem.

What is a chargeback?

A customer can dispute a payment for several reasons, the main ones being:

• The purchased item was not delivered
• A charge may have been duplicated by mistake
• A technical issue may have resulted in the charge being made
• The card holder’s card information may have been compromised¹

The customer may contact you directly to try and resolve the problem and, as we will see later, this is by far the best option for both of you. On the other hand, if the customer opts to contact their bank first instead, this will trigger a negotiation process which may result in the customer receiving their money back if the bank’s findings are in the customer’s favour. This reimbursement is called a chargeback.

The difference between chargebacks and refunds

A frequent reason for customers wanting their money back is simply that the item they bought turns out to be not quite as desirable when they receive it in person. For example: wrong colour, wrong size, or simply not looking quite the way the customer expected when they eagerly handed over their payment card details. Inevitably, the situation happens more readily with online purchasing when decisions are based solely on the information and images online.

Additionally, online purchases provide more scope and opportunities for items getting damaged during shipment or the wrong item getting sent in error. Many retailers, particularly the large ones, are set up to deal with these situations. They boast a slick operation offering customers the chance to return goods within a certain time frame (sometimes at the retailer’s expense, with a prepaid address label to use with a specified courier) and a form asking the customer to specify reasons for the return. On receipt of the goods, the merchant instructs his bank to reimburse the money to the account from which the payment was originally made. This is an arrangement between the customer and the merchant and is known simply as a refund.^{2, 3}

So far, so good. But what happens when the cause for dispute is less clear? For example, you, as the seller, are unhappy with the reasons for the product’s return, or the customer claims the card was used fraudulently? Here’s where it gets more complicated. If you and the customer cannot come to an amicable agreement, the customer can file a claim to his credit card issuer. This leads to a cumbersome process, which is likely to be costly for you.

How the chargeback process works

There are several parties in the chargeback process: the customer/cardholder; the merchant; the customer’s bank (issuer); the merchant’s bank (acquirer); and the credit card network which owns the card used in the transaction. In addition, payment processor and payment gateway companies that facilitate the merchant’s transactions may also become involved. The merchant needs to provide input, otherwise the claim defaults in favour of the customer. The process may vary in different cases, but a simple and typical one will follow this procedure:

• The cardholder contacts his bank to dispute the transaction
• The issuer decides whether the cardholder has a potential claim. If the issuer makes a decision against the customer, reimbursement is denied and the case is closed. However, in most cases, the bank will allow the claim to proceed and give the cardholder a provisional credit for the disputed sum
• The issuer will inform the card network of the chargeback
• The card network will in turn inform the acquirer
• When the acquirer has been notified, it will debit the merchant’s account and, in addition, charge it a chargeback fee
• The acquirer will then notify the merchant of the chargeback. The process can take time, and this will usually be the first the merchant hears about it. The merchant must then decide whether to accept or challenge the chargeback before their time to respond expires
• The final arbiter is the issuer. If the issuer agrees the merchant's dispute is legitimate, it returns the provisional refund to the merchant’s bank account. If not, the chargeback stands

As can be seen, the process is complicated and time-consuming. Not surprisingly, many chargebacks are agreed simply because the merchant has neither the time nor resources to challenge it, and for many it has become simply another business cost. However, not only can the fees and other overheads add up to twice as much as the initial transaction, but each chargeback can potentially damage a merchant’s reputation. A high number of chargebacks, awarded for whatever reason, count against the merchant and can result in fines and even a terminated account.⁴ Fighting chargebacks can help you recover revenue and will show issuers that you are not willing to give in to them by default. Also, failure to fight against suspected fraud (because it is often deemed a losing battle) only encourages even bolder criminality.⁵

It is therefore in your interest for any problems between you and your customer to be resolved amicably, if possible, before the matter has a chance to escalate further. But the statistics don’t bode well. Only 14% of consumers who file a chargeback contact the merchant first. More worryingly, customers who have filed a chargeback are nine times more likely to do so again.⁶

The chargeback system was introduced to provide security to customers. With the threat of not being paid for mishandled transactions, selling substandard goods or items that didn’t arrive at all, merchants were encouraged to trade responsibly and with transparency. Chargebacks give a further layer of protection to the customer as they can also be recompensed for fraudulent use of their credit or debit card.⁷ However, the complexity of processing chargebacks and the time it takes to do so mean that for genuine claims, it is recommended that customers always first approach the merchant to seek reimbursement. Why? Because they are likely to be paid quicker. Equally, merchants are encouraged to find a prompt settlement if the claim is considered genuine in order to avoid the costs and repercussions of chargebacks.

The difference between merchant error and true fraud chargebacks

Chargebacks are often divided into three categories, which will determine how they are treated.

• Merchant error chargebacks. These are the most common type of chargebacks, and while unintentional, are bad for business, both in terms of your credibility and your profitability. They can arise for several reasons, from poor customer service or faulty product fulfilment to system errors, unwanted recurring payments or authorisation errors
• Friendly fraud chargebacks
• True fraud chargebacks⁸

Understanding chargeback fraud

Alongside legitimate reasons for chargebacks arising from merchant error are those that are obtained with criminal intent. And these can be divided into two categories – ‘friendly fraud’ and true fraud.

Friendly fraud chargebacks. Whereas chargebacks were set up to protect the customer from negligent merchants to a large extent the tables have turned: merchants are losing significant sums of money being defrauded by their own customers. So the term ‘friendly fraud’ chargebacks is misleading, but gets its name from the fact that the claims frequently have an air of being genuine. But it is, quite simply, theft. Here, your customer orders an item, receives it, but finds an excuse for claiming that they have not received the goods. Some 40% of consumers who commit friendly fraud will do so again with two months.⁹

These are the usual claims customers make when attempting to obtain a friendly fraud chargeback:

• The item wasn’t delivered
• The item does not match the online description and they don’t want it
• They returned the item, but didn’t receive a refund
• They cancelled the order, but it was still sent
• They don’t remember making the purchase, so their card must have been compromised¹⁰

True fraud. Apart from your own customers defrauding you, there are criminals who either take over a cardholder’s account or steal a cardholder’s identity. In taking over a cardholder’s account, the fraudster acquires a cardholder’s details and uses them for themselves. Stealing an identity usually involves stealing a genuine social security number or personal identification number, sometimes from a deceased person or from a child. Next, fraudsters build up a ‘synthetic identity’ around these identification numbers to match them with fraudulent online accounts. While any type of fraud is a cost to businesses, true fraud is unlikely to result in chargebacks – unless the fraudster is audacious enough to add a friendly fraud chargeback to their crimes.

Cyber fraud is much easier to carry out during remote purchases, i.e. when the credit or debit card being used does not need to be physically present. In 2021, the fraudulent purchase of remote physical goods online was responsible for more than 47% of fraud losses.¹¹

Preventing chargebacks

It is estimated that every dollar paid back in chargebacks represents an actual cost to businesses of US$2.94.¹² But paying out for this doesn’t have to be an inevitable cost of doing business and PayPal has plenty of useful tips on how to prevent chargebacks. As a start, there are some basic steps to ensure good relations between you and your customers that could lessen their need to claim from you.

Ensure you provide contact information – an email and/or phone number. And be responsive when they get in touch. Finding a sympathetic ear will lessen a customer’s anger and frustration about their transaction issues. If a customer is planning to file a chargeback with their credit card company, suggest they open a dispute in the PayPal Resolution Center instead, to give both parties a chance to work things out. And don’t forget to provide a clear returns and refund policy so the customer knows their responsibilities if they don’t want to keep their purchase.

The three most common specific problems that are likely to occur with an order are: the customer did not receive the product; the item is significantly different from its description; unauthorised transactions.

Here’s what you can do to minimise these issues:

Item not received

• Provide realistic delivery dates
• Ship with a qualified shipping service that provides online tracking. Don’t use a shipping service suggested by your customer in case it’s a scam to reroute the package which will void your insurance
• Order shipping insurance for valuable or fragile items. A good shipping company can help you choose the right cover
• For valuable items, purchase signature confirmation
• Delay shipping valuable items or shipping them overnight in case it’s a scam to sell them quickly on arrival
• If you know a shipment is going to be delayed, you can also post messages to that effect on your website
• If you’re using a dropshipping model, e.g. the product is despatched by third-party company, vet it carefully and be wary of shipping to high-risk countries
• If an item is out of stock, advise your customers promptly with details on when it will next be available
• Issue returns quickly¹³
• See PayPal’s User Agreement for further information on PayPal features

Significantly not as described

• Provide pictures – from several angles – and detailed descriptions
• If relevant, disclose any functional defects and cosmetic damage to items clearly and accurately

Unauthorised transactions

When buyers open a dispute or request a chargeback as they believe a purchase was made on their PayPal account without permission, it may be fraud or just a genuine mistake. Here are some warning signs that an order may be fraudulent:

• The shipping address is in a high-risk location. A list of high-risk places well-known for fraud can be found through an online search
• A new customer’s order is larger than typically normal, particularly for highly demanded items such as electronics
• The customer asks to change the shipping address after paying. Fraudsters initially enter a valid address so fraud systems won’t catch them, before contacting you to change them
• An abnormal number of international orders within a short period of time
• An abnormal number of orders at an unusual time of day
• Several orders from different customers with the same shipping address. Fraudsters often make orders from several stolen credit cards, then have the orders shipped to one address
• Multiple orders from the same PayPal account around the same time. Fraudsters may place smaller, separate orders to avoid detection as low-priced orders normally receive less scrutiny than large ones
• Overpayment. A fraudster will overpay for an order and then ask for the extra money to be returned through a wire transfer or to their shipping company. If someone overpays you, return the extra money through PayPal
• An order consists of multiple requests for the same item. Why would a customer need 50 pairs of the same shoe? Ask yourself if the quantity ordered of the same product makes sense
• A customer uses a suspicious email address. Beware of email addresses that seem unusual, like ‘knh$$yro123456@gmail.com©, or undeliverable emails. Legitimate customers are more likely to use email addresses that contain their name
• An order has a suspicious shipping address. Before shipping an expensive order, make sure you know where it’s being shipped. Criminals may ship orders to freight forwarders, shipping companies, PO boxes, or vacant properties to remain anonymous

PayPal’s Seller Protection Policy

If you are sent an unauthorized payment – for example, from a hacked account – or a buyer claims through PayPal's Buyer Protection Program that they didn't receive their item, our Seller Protection policy may cover you for the full amount of the payment on eligible sales. For more information, see our User Agreement.