In 2022, the United Kingdom had the highest annual growth in online retail sales since 2007. Sales increased by 36%. While an increase in online sales is obviously good news for ecommerce retailers, more online transactions mean more opportunities for ecommerce fraud. That includes chargeback fraud.

It’s also estimated that up to 44% of total chargebacks could be cases of intentional or unintentional friendly fraud. According to the Chargeback Field Report, the majority of participating merchants noticed a significant increase in chargeback fraud across 2023. Over half of the merchants surveyed admitted that friendly fraud was a big concern for their business.

With that in mind, let’s define what’s meant by chargeback fraud, what it involves, and ultimately how best to prevent it.

What is chargeback fraud?

Chargebacks were introduced as a means of providing extra protection for debit and credit card users. The chargeback process allows cardholders to get their money back in case of an issue with the merchant or purchase. These issues could include if they haven’t been able to receive a refund, if the merchant doesn’t honour their return policies, or if they believe the merchant charged them incorrectly.

A chargeback is essentially the reversal of a debit or credit card transaction. With standard refunds, it is the customer that requests their money back from the merchant or service provider. However, with chargebacks, the customer’s bank or card issuer retrieves the funds via a reversal on the customer’s behalf.

A customer may raise a chargeback with their bank for the following reasons:

• A customer doesn’t receive the goods or services they paid for

• A customer is unsatisfied with the items they paid for and wants to receive their money back

• A customer doesn’t recognise the charge on their credit card statement and believes it wasn’t them making the payment

• The customer was expecting a refund which they haven’t yet received on their account

• An error occurred with the sale. This could be that the customer was charged twice for one order, charged the wrong amount or charged for a subscription plan after cancelling

• The vendor is no longer operating, making it impossible to request a refund

These are all legitimate reasons for chargebacks. But a customer might also make a false chargeback claim. This is considered chargeback fraud. An example of a fraudulent chargeback is when a customer falsely claims not to recognise a payment on their credit card statement and pursues a chargeback with their bank.

Typically, the bank or credit card company will take the customer’s side during a chargeback request, refunding the charge and processing a chargeback dispute with the merchant. This means that the business indirectly repays the customer and will have to pay chargeback fees ranging from £10 to £20.

Is chargeback fraud the same as friendly fraud?

Illegitimate chargebacks could stem from intentional attempts to defraud the merchant. This is akin to shoplifting online. However, it’s sometimes without malicious intent, which is why it is also referred to as friendly fraud or first-party fraud. For example, a ‘fraudster’ may ask for a chargeback but, in reality, it’s someone who:

• made a purchase and forgot about it

• didn't recognize the billing descriptor on their bank statement

• made an in-app or in-game purchase by accident

It can also include ‘family fraud’. Here, a child or family member makes a transaction using a relative's card information. Their relative then disputes the transaction.

What are the costs related to chargeback fraud?

Chargebacks, whether legitimate or fraudulent, affect a business’ revenue. They inevitably increase the merchant’s chargeback rate, the percentage of sales that experience a chargeback request. There are several direct and indirect costs that result from chargeback fraud, including:

Direct costs

Chargeback fees

Every chargeback claim comes with a fee attached. Chargeback fees typically range from £10-20 per claim. These fees, in addition to credit card payment processing fees, can amount to a hefty sum for a business.

Lost inventory

Ecommerce businesses have to refund the customer in the case where the bank decides in favour of a customer’s chargeback request. However, the customer is under no obligation to return any purchased goods.

Monitoring program costs

Card payment processors (like Visa and Mastercard) monitor your chargeback ratio (also called chargeback rate). This refers to the ratio of the total number of sales to the number of chargebacks received during a period. If the ratio is too high — Visa’s threshold is 0.65%, whereas Mastercard’s is 1% — card networks may place you on their monitoring program. Once you’re on a program, card networks charge monthly fines and fees until your chargeback ratio falls to below the relevant threshold.

Indirect costs

Operational costs

Processing an order involves operational costs and resources. These include production costs, packaging, shipping, logistics and transportation of goods. When chargeback fraud occurs, none of these expenses are remunerated, meaning lost time, resources and money.

Merchants must also take into account the time, personnel, and resources required to dispute any chargebacks. Often this entails hiring dedicated fraud analysts for fraud detection and monitoring. In fact, fraud detection and prevention solutions are becoming increasingly popular — particularly with the development of AI and machine learning. Fraud detection solutions are estimated to have a global market worth £31.38 billion, projected to reach £86.93 billion by 2030.

Cost of lost opportunity

Every order that results in a chargeback could have been a successful order with another customer. Chargebacks therefore cause the indirect cost of a lost opportunity for revenue. Over time, these costs can compound and impede company growth.

How can businesses contest chargeback fraud?

A business can fight chargeback fraud by submitting a rebuttal letter to the issuing bank with evidence indicating that the dispute is fraudulent. This process is known as chargeback representment. After submitting the letter, it is up to the issuing bank to review it and come to a decision.

A rebuttal letter should be short and to the point and include the following:

• Transaction receipt: you can find this in your payment gateway. It will include the AVS and CVV match, verifying that the cardholder is the same individual who carried out the transaction.

• The order invoice: this should include details of items sold, the purchase date, a customer name, billing and shipping addresses and a tracking number.

• Tracking confirmation: this should prove that the items arrived at their destination. If you’re selling software, you may need to find another way of proving that the customer received and used the product.

• Your company’s terms and conditions: include specific sections relevant to chargebacks.

• A copy of your checkout page: on this page, there should be a box that customers must tick agreeing to your terms and conditions.

How to prevent chargeback fraud

There are several precautionary measures you can take to prevent chargeback fraud and minimise the associated risks to your business:

• Send confirmation emails for all orders: this makes it harder for fraudsters and bad actors to pretend that they didn’t make a payment to your business. Legitimate customers are also less likely to mistake any charges as a fraudulent transaction.

• Require a signature upon delivery: this serves as proof of delivery, making it harder for customers to claim they never received their order.

• Use alternative payment methods: merchants can reduce chargeback fraud by using payment methods alternative to credit and debit card payments. Open banking payments do not have a chargeback mechanism, but instead, have their own consumer protections designed to keep both customers and businesses safe.

How can open banking help you prevent chargeback fraud?

Open banking payments, often referred to as pay by bank at checkout, are a useful way to virtually eliminate chargeback fraud altogether, by avoiding credit card processing entirely.

The TrueLayer Payments API enables shoppers to pay instantly in a few clicks, authenticating the payment via their banking app.

Discover more about open banking payments and how they can benefit your business in our comprehensive guide.