What is the true cost of your chargeback?

Andy Tweddle, Payments writer
4 Oct 2022
Multiple pie charts

Chargebacks are a common concern for ecommerce businesses. Any brand that collects payments using credit or debit cards will invariably face chargeback requests on a regular basis. Chargebacks were originally designed to make customers feel secure when paying with cards, but in reality have several drawbacks.

Merchants that become frequent targets of chargeback requests will face additional problems. High rates of chargebacks can lead to card-acquiring contracts being cancelled, whether or not those claims are illegitimate or fraudulent. This problem has become so bad, many acquirers have started bundling chargeback protection insurance into their overall fees.

So what does a chargeback actually cost a business? This article breaks down the different costs associated with chargebacks, from the straightforward fees to the hidden costs that come with responding to and fighting chargeback requests.

What is a chargeback fee?

To understand the fees and costs of a chargeback, you first need to know what exactly a chargeback is and why one would occur. A chargeback is the reversal of a debit or credit card payment by the cardholder’s bank on behalf of the cardholder. A customer can request a chargeback for several reasons — more on that below — but it generally boils down to customer dissatisfaction.

Upon initiating a chargeback request, the customer receives a conditional refund. The acquiring bank withdraws money from the merchant’s bank and transfers it back to the customer’s account. The merchant will receive a chargeback reason code so they can better understand the reason for the request.

At this point the merchant’s bank will carry out a full investigation into whether or not the request should be upheld. At this stage, the merchant’s bank will notify the retailer and ask for evidence, which can be time consuming and resource intensive.

It’s your job, as the merchant, to provide all required evidence, such as receipts, delivery confirmation, and customer service records in the timeframes set out by your bank. But the customer’s bank makes the final decision.

If the chargeback is upheld, the merchant must return the money to the customer, as well as pay an additional fee to the acquiring bank. In the UK, the fee typically ranges from £15-25 but can be as high as £150. The fee is designed to incentivise merchants to act in a way that avoids chargebacks.

Why do chargebacks occur?

Chargebacks were originally designed as a type of consumer protection for credit and debit card payments, to give customers peace of mind when using them. For example, if a customer received faulty goods, and were unable to get a refund from the merchant, they would be safe in the knowledge that they could request a chargeback from their bank.

Specifically, there are seven reasons a customer can initiate a chargeback request:

  1. Card processing errors, including being charged multiple times for the same purchase

  2. The cardholder doesn’t recognise the transaction

  3. Merchandise or service differs from the description

  4. Ordered goods aren’t received

  5. Received goods are defective

  6. Agreed upon services didn’t take place

  7. The seller has gone out of business, so the customer cannot request a refund

Unfortunately, some chargebacks aren’t made in good faith. Sometimes a customer makes a fraudulent or illegitimate chargeback claim. For instance, if a customer does actually receive goods from your business, but claims not to have and then initiates a chargeback, the claim would be fraudulent. This is referred to as chargeback fraud or friendly fraud.

Chargeback fraud has become a big problem for merchants, with 8 in 10 merchants seeing an increase in friendly fraud in 2021.

How much do chargebacks cost?

On the face of it, a chargeback has two costs to a business:

The transaction value: If a chargeback request is upheld, the merchant must return the money associated with the transaction back to the customer.

The chargeback fee: the fee charged by the acquiring bank to the merchant, typically £15-25, but depending on the scheme and type of dispute can be upwards of £150.

But there are, of course, further costs associated with chargebacks, especially if you want to spend time disputing chargebacks that you feel should not be upheld. These costs, sometimes referred to as ‘hidden’ costs, include:

Lost inventory: In the case of chargeback fraud, your ecommerce business will need to refund the purchase. However, the customer is not obligated to return their purchased goods if the bank agrees with the customer’s chargeback request.

Monitoring program costs: Card schemes (like Visa and Mastercard) monitor your chargeback ratio (also called chargeback rate). If the ratio is too high (Visa’s threshold is 0.65% and Mastercard’s is 1%), you may be placed on their monitoring program. Once on one of these, you can be charged monthly fines and fees, until your chargeback ratio falls to below the relevant threshold.

Chargeback reversal administrative costs: When a customer initiates a chargeback, you need to quickly consider whether you should attempt to reverse the chargeback. You should only fight the chargeback request if you can provide the evidence to prove it should be overturned. Even if you are successful, the process of gathering evidence and submitting this to your bank will require time and effort from your team.

Lost opportunity costs: Every order which results in chargeback could potentially have been an order with another customer. Chargebacks cause the indirect cost of a lost opportunity for revenue, which over time can compound and impede company growth.

Operational and logistical 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 reimbursed, meaning lost time and money.

It is tricky to assign a specific cost to the above indirect chargeback costs. But Justt, a chargeback dispute software, estimates the average chargeback costs a business 2.5x the amount of the transaction. That means a chargeback request for a £100 transaction will cost your business about £250 in total.

How much did chargebacks cost businesses in 2021?

Chargebacks are a reality for online businesses that accept card payments, and as ecommerce continues to grow, so too do chargeback requests.

According to Mastercard, global projected chargeback volume reached 615 million in 2021. Using internal data, Chargebacks911 estimated that this volume of chargebacks cost global businesses over $117 billion in 2021 alone.

While chargebacks are inevitable for merchants who collect payments via credit and debit cards, it’s the likelihood of fraudulent chargebacks that can really increase the financial burden on a business. It’s estimated that up to 86% of total chargebacks could be cases of intentional or unintentional friendly fraud. And according to the Chargeback Field Report, the majority of participating merchants noticed a significant increase in chargeback fraud across 2021.

How can you reduce the cost of chargebacks?

There are three main approaches you can take to reduce the cost of chargebacks:

  1. Reduce the likelihood of a customer requesting a chargeback

  2. Increase the likelihood of reversing a chargeback

  3. Use a payment method that does not have a chargeback mechanism at all

There are several ways to make sure a customer has a good experience with your brand, minimising the chance of them requesting a chargeback. Make sure your customer service team responds to any customer complaints or feedback promptly, offering replacements or refunds if necessary. Be transparent with shipping and delivery times, because a customer who is frustrated with the time it takes to receive their goods may request a chargeback.

We’ve compiled a more detailed list of tactics and tips for reducing chargebacks.

Even with the best customer service, things still go wrong — and fraudulent chargebacks will still happen — so you need a strong process for reversing chargebacks. In short, you need to select only chargebacks that aren’t legitimate, respond to the issuing bank promptly, and gather evidence to help your case.

For a full breakdown, see our guide to chargeback reversals.

Finally, alternative payment methods, such as bank transfers and open banking payments, are all ways to collect payments from your customers without relying on card payments. While they have their own consumer protection rules, they don’t have chargeback mechanisms. Payment methods like buy now pay later (BNPL) and mobile wallets (such as Apple Pay) are built on top of card payment technology, so can still be subject to a chargeback request. Direct debits have the direct debit guarantee, which works similarly to chargebacks.

Open banking payments can help eliminate chargebacks entirely

Open banking payments (also known as ‘instant bank payments’) are an alternative to card payments that eliminate the chargeback process completely. They are also cost-effective, have strong customer authentication (SCA) baked in and settle instantly.

Read our definitive guide to open banking to learn more about how open banking payments will benefit your business.

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