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While payments by credit or debit cards bring huge benefits to businesses in terms of speed and convenience, one disadvantage is chargebacks, which can result when a customer disputes a transacted item. We’ll show you how to prevent them from happening unnecessarily.
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.
A customer can dispute a payment for several reasons, the main ones being:
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.
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receipt of the goods, the merchant instructs his bank to reimburse the money to the account from which the payment was originally made.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.
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:
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.
Chargebacks are often divided into three categories, which will determine how they are treated.
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.
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:
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
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
Significantly not as described
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:
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.