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TheMerchant’sGuide toChargebackManagementWHITEPAPER

Don’t count your chickens before they hatch.IntroductionTo some extent, chargebacks are like eggs that didnot hatch. You already counted a sale as revenue,only for it to be disputed by the customer, thenreversed by the bank a few days later.A chargeback occurs when cardholders ask theirbanks to reverse a charge. This could be because thetransaction is fraudulent, unauthorized, or due to anunsatisfactory shopping experience with a merchant.If the bank approves the request, it’s forwarded tothe merchant who is legally required to reimbursethe payment.As intended, the ability to request a credit cardcharge be reversed gives shoppers protectionagainst fraud. However, it’s also fertile ground forboth real fraud and friendly fraud to flourish.The most obvious impact of chargebacks onmerchants is revenue loss. However, it cuts muchdeeper, especially considering how competitivethe current ecommerce landscape is. For instance,incurring chargebacks leads to wasted customeracquisition spending.Luckily, merchants are not powerless in the face ofchargebacks. There are several things online retailerscan do to fight this problem. The key is to know howchargebacks work, the best practices to managecosts and how to increase your dispute success rate.vesta.io02

A brief history of chargebacksChargebacks:the basicsThough you likelyunderstand a few basicthings about chargebacks,the information here ismeant to enrich or fill thegaps in your understandingof the history, howthey work and otherfoundational knowledge.1946The first multi-merchant credit card1958The first card with revolving credit1968Creation of the Truth in Lending ActDuring the first half of the 1900s, most ofthe credit cards that were being issued wereproprietary. In 1946, New York banker JohnBiggins created Charg-It Card, the first cardthat was honored in multiple merchants, butonly clients of the Biggins’ Franklin NationalBank were eligible to get one.In 1958, BankAmericard was launched,which was the first credit card with revolvingcredit and could be used at any participatingmerchants. Here’s something interesting.Instead of applying for a card, BankAmericardshipped cards to random people. This createda problem as some of those who receiveda card in the mail didn’t have the financialcapacity to repay the money they owed.In 1968, the Truth in Lending Act (TILA) waspassed to calm fears associated with usingbank cards. The TILA required lenders todisclose credit terms that consumers couldeasily understand.vesta.io03

1974Launch of the Fair Credit Billing Act(FCBA)In 1974, Congress amended the Truth inLending Act which gave birth to the FairCredit Billing Act. This was arguably thefirst law that enabled credit card holdersto dispute charges. The FCBA allowedcardholders to dispute charges that were atleast 50 and met the following conditions: Unauthorized charges The amount charged was incorrect Charges for goods that the customers didnot receive or accept The charge reflects a wrong date Calculation errors The goods were not as describedor damaged1978Enactment of the ElectronicFund Transfer ActThe TILA and the FCBA only covered creditcard holders. In 1978, the Electronic FundTransfer Act was passed to give the sameprotection to debit card holders, althoughits provisions were not as comprehensive asthe FCBA.vesta.io04

The 5 mostcommonreasons forchargebacksOne of the most crucial steps in fightingchargebacks is knowing the reasonswhy customers file for refunds with theirbanks in the first place.Let’s get into the minds of yourcustomers and explore their topmotivations and intentions when theyfile for chargebacks.1“I believe I’ve been the target of fraud.”Fraud is the most legitimate reason forchargebacks and exactly why chargebackrelated laws were created in the first place.30%30% of allchargeback claimsare filed due tounauthorizedtransactions.vesta.io05

2“I didn’t receive my order.”Lost parcels, issues with courier services,stock issues, delays in order preparation—there are a host of reasons for goods notreaching your customers.How do you know whether your customersare telling the truth or just avoiding payingfor some reason? (More on this later).Not receiving anonline order is thesecond most commonreason shoppers filefor chargebacks,accounting for 26%of all claims.326%“This isn’t what I ordered.”If a customer ordered a fitted sheet for aqueen size bed and received one for a kingsize bed, they can (and will) file a chargebackif unable to sort things out on their own withthe merchant.15%This type ofchargebackrepresents 15%of all claims made.vesta.io06

45“Item is not as described.”This is arguably the most disputed, sensitiveand controversial type of chargeback. Whencustomers feel they were deceived intobuying a product, they (understandably)want their money back. This is closely relatedto another common chargeback reason:customers filing for credit charge reversalswhen the items they received didn’t matchtheir expectations. These claims may belegitimate or may be due to unreasonableconsumer behaviors.“I was billed incorrectly.”Incorrect credit card charges can manifest indifferent ways. This could mean getting billedtwice for the same purchase, getting chargedfor shipping when it’s supposed to be free,and other clerical errors.These are just the top overarchingreasons customers file for chargebacks.If you’ve experienced chargebacksbefore, you probably already knowthat there are additional causesrepresented by reason codes. That said,understanding the above-mentionedreasons cover the most common—andmost costly—types of chargebacks thatplague merchants.vesta.io07

An overview of the chargeback processOne major complaint of merchants when it comes to the chargeback process is it’s toocomplicated. In an attempt to simplify things, we created the diagram below.Is the disputevalid?Issuing bank reviewsthe dispute anddecides whether it’valid or not.Customer calls theirissuing bank to filea disuputeYesNoThe issuing bankimmediately issues credit tothe customer and forwards thedispute to the card network.End of thechargeback processNoDoes themerchant disputethe chargeback?YesThe merchant reviewsthe chargeback anddecides whether todispute it or not.The merchant gatherscompelling evidence relatedto the transaction in questionand forwards it to theacquiring bank.The acquiring bankreviews the evidenceand forwardsit to the card network.The card networkpasses the evidenceto the issuing bank forfinal review.The above diagram can have additional steps ifthe cardholder decides to dispute again. If thecardholder opts to do so, the entire processstarts again. This is called pre-arbitration. Ifthe merchant wins the pre-arbitration, thecardholder can dispute again and the issuingbank starts the arbitration process. This willautomatically incur a 250 charge againstthe merchant. The merchant will recoup thisamount if they win the arbitration. However, ifthe merchant loses, it will incur an additionalThe acquiring bankforwards the chargebackto the merchant.Is thecompellingevidencesufficent?NoThe card network facilitiesthe reversal of funds from themerchant’s bank account viaan acquirer. This part of theprocess involves fees that arelater passed on to the merchantYesThe merchant wins and thechargeback is reversed. Thecustomer loses the credit thatwas initially given.The merchant losesand the customerretains the credit. 250 charge or more (some card networksimpose fines from 500 to 900).This is why a number of merchants arehesitant to dispute chargebacks, especiallybecause only 21% of chargeback disputes areruled in favor of ecommerce retailers.That leads to the billion-dollar question(figurative and literal: How can chargebackspotentially cripple your business?vesta.io08

Thefrighteningfacts on howchargebacksimpacte-commercebusinessesThe facts are frightening:Repercussions ofchargebacks in thee-commerce industry arewell documented. They’rewidespread and theyhamper the growth ofhardworking merchants likeyourself. 40BillionA multi-billion dollar problemMerchants are currently losing upwards of 40 billion annually to chargebacks. In manyof these cases, the online retailers were notat fault, but they still shoulder the burdenof lost revenue, unrecoverable goods andchargeback fees for the disputes they lose.These chargeback-related costs force severalmerchants to raise their prices to recoversome of their losses.49%A product of fraud20%Growing at an alarming rate58%Consumers are pulling thetrigger on filing chargebacksAs mentioned earlier, fraud accounts for mostof the chargeback claims filed by shoppers.It’s not surprising that 49% of the revenuemerchants lose due to fraud can be attributedto chargebacks.Chargebacks are bulldozing the e-commercelandscape, and increasing at an alarmingrate. The number of chargebacks onlinemerchants need to deal with is growing by20% annually.It’s time to face somescary statistics:In an ideal world, chargebacks should be thelast resort of consumers. In the case of unmetexpectations, defective goods, and wrongproducts delivered, the customers shouldreach out to the merchants first to sort thingsout. However, 58% of shoppers immediatelycontact their banks to file for a chargeback.vesta.io09

18%Merchants on the losingend of chargeback disputesMerchants are not taking chargebacks lyingdown. In fact, 80% of merchants disputechargebacks they believe are illegitimate.However, only 18% of online retailers arewinning more than 60% of their chargebackdisputes. This means that most of the time,the majority of merchants are losing andare bearing the high costs involved in thechargeback dispute process.71% 45.27Not-so-friendly fraudAmong all chargeback claims filed, 71% arechargeback fraud and friendly fraud. There’sa slight difference between the two. Friendlyfraud involves chargebacks filed because ofhonest mistakes from customers (i.e. theydidn’t recognize a specific legitimate chargeon their credit card). Chargeback fraudinvolves customers trying to use their rightto file chargebacks to avoid paying for goodsthey purchased.Wasted Customer Acquisition SpendThe average cost per acquisition (CAC)or the cost to acquire a new customer inecommerce is 45 This means that aside fromthe revenue and the fees that merchants losedue to chargebacks, the money they spent inacquiring new customers also goes downthe drain.vesta.io010

If chargebacks are left unchecked, you can easilyhemorrhage hard-earned revenue. There are otherrisks associated with chargebacks. For instance, a highchargeback ratio can lead to the cancellation of yourmerchant account. The account preventing you fromaccepting payments from that specific payment channel.This will lead to further customer and revenue loss.The statistics are indeed scary.Fortunately, it’s not all doom and gloom for merchants.In fact, merchants are far from being helpless when itcomes to preventing or minimizing chargebacks.vesta.io011

The 10commandmentsof chargebackmanagement“The worst time to develop a plan is when you geta chargeback. Chargebacks can catch owners bysurprise very often, but then they have a minimalamount of time to respond, so there’s no time tolearn what it is or how to respond.”– Chip RogersPresident and CEO, Asian American Hotel Owners AssociationThe question is not whether chargebacks willhappen, but rather: How strong are the defensesyou put in place to minimize their effects and howprepared are you to mitigate loss if you get hit with achargeback claim?vesta.io012