What is a chargeback, and why do they matter for merchants?

What are chargebacks?

So what is a chargeback? A chargeback occurs when customers report or dispute a charge with their debit or credit card issuer, asking them to issue a refund.

Chargebacks are typically initiated by the original buyer. While they do not have to pay a chargeback fee to start the chargeback process, they must file the dispute within a specific time frame — usually up to 120 days after the transaction date.¹ The customer should always contact the seller first to try and resolve the issue.

Chargeback example

Here’s a quick example of how a chargeback works: Say a buyer purchases a large, six-foot standing mirror on their credit card. A week later, the mirror arrives chipped or shattered. The merchant insists that the mirror was packed safely. The customer then decides to file a chargeback request with the bank that completed the transaction — in this case, the credit card issuer.

In this instance, other reasons for a chargeback request could include:

• The mirror came in a different color than what was indicated online
• The mirror’s dimensions were different
• The customer was charged twice for only one item

If the claim gets approved, the customer receives the amount back in full to their original form of payment. However, if the merchant disagrees with what is stated in the claim, they can defend it and the customer’s credit card issuer will have to determine who is responsible.

What is the difference between chargebacks and refunds?

Though chargebacks and refunds both involve the return of funds for a transaction, there are some major differences.

A refund is the return of funds to the customer from the seller. Refunds are always driven by the merchant and are considered voluntary. For the seller to issue a refund, they come to an agreement with the customer so they can bypass the need to get the debit or credit card issuer involved.

In the case of the standing mirror, the buyer could have contacted the merchant directly, requesting a refund for the damaged item. If the merchant agrees, the buyer would happily receive the refund to their form of payment some days later. This leads to a better relationship between the merchant and the customer, and it works to benefit the seller as well.

However, if the buyer has trouble reaching the merchant or the merchant refuses to honor the damage claim, the buyer could escalate the dispute into a chargeback with their credit card issuer. In contrast to the refund, a chargeback is always initiated by the customer.

Chargebacks vs disputes vs other terms

What is a chargeback dispute? Before we discuss the specifics of chargebacks, it’s helpful to first understand some common terms you may encounter in the process:

• Chargeback or chargeback dispute: A claim against a transaction initiated by a customer with their bank or credit card issuer, resulting in a forced payment reversal. The merchant doesn’t feel responsible for the breakage of the mirror, refuses the refund, and a chargeback dispute is filed by the customer.
• Pre-arbitration (pre-arb): This is when a case is filed by a bank after the chargeback has been reversed. This usually happens when the customer claims to have further evidence or arguments about the original dispute.
• Retrieval: A request initiated by a customer for more information about a charge. This is when the customer asks the business to help explain what happened.

Reasons for chargebacks

There are numerous reasons for chargebacks, such as if a customer:

• Doesn’t receive the item they ordered and paid for — for example, if the mirror they received is markedly different from the one they saw online.
• Receives a damaged or defective item — this would be if the customer received a broken or damaged mirror.
• Doesn’t recognize the debit or credit card charge — the charge on the customer’s statement has no contact information and they don’t remember making the purchase.
• Is charged more than once for an item — there are clearly double charges on the customer’s statement and the merchant won’t do anything about it.
• Claims their form of payment was used to purchase an item fraudulently without their permission or authorization — the customer did not order this item or did not receive this item.

How do chargebacks work?

Though the chargeback process can vary depending on the debit or credit card issuer handling the case, the chargeback process generally follows these steps:

Why do chargebacks matter for merchants?

Chargebacks not only hurt your bottom line, but they can also hurt your business by:

• Incurring fees and costs: When you deal with a chargeback, you may be subject to additional charges from card issuers.
• Impacting your chargeback ratio: Whether you win or lose a chargeback request, it will affect your chargeback ratio, which, in basic terms, determines your standing with credit networks. The more chargebacks you encounter as a seller, the higher the likelihood they flag you as a high-risk merchant, meaning your flat-rate or tiered pricing structure could go up, adversely affecting your bottom line on every charge.
• Damaging your reputation: Working out a problem directly with a customer can lead to a better overall purchase experience and increased loyalty. Refunds improve your goodwill with customers and help your reputation as a merchant.

There are ways to win chargeback disputes. Learn how to manage chargebacks.

What can help you win a chargeback dispute?

Factors that could affect your likelihood of winning a chargeback dispute include:

• Customer service history: The customer service experience you provide indicates a record of your relationships with your customers. If you prioritize goodwill with customers and normally make it easy for them to get a refund, then the fact that this instance has gone to chargeback may be an indication that you’re in the right.
• Nature of your business: Different businesses face chargebacks for different reasons. If you sell goods online, there’s the possibility of breakage during shipment. If you provide services, customers may ask for chargebacks if they are not satisfied with the work you performed.
• Good recordkeeping: The quality of the documentation you can provide to support your case is paramount to your ability to defend yourself should a chargeback arise. This can help prove the condition of the goods you supplied or the service you provided.
• Due diligence: The effectiveness of your chargeback management and response procedures is a reflection of how you do business overall and how prepared you are to handle a chargeback dispute.

Chargeback protection for merchants

Chargeback protection for merchants can help minimize the financial impact of chargebacks by leveraging tools to help detect fraud, reduce customer friction, and contest cardholder queries.

The good news is that there are payment partners, like PayPal, that offer chargeback protection services to help you handle and avoid chargebacks. This can help protect your business from scammers who want your goods and services but don’t want to pay you what you’re owed.

Some bad actors may use fraudulent cards, phone numbers, or shipping addresses. It can be far too time-consuming for you to validate every single card that comes in. And when that happens you are out the cost of your product, as well as the lost payment for that product. Take advantage of the help that a responsible payment partner offers.

Fraudulent chargebacks: What is friendly fraud?

Also known as friendly fraud, chargeback fraud happens when a customer purchases items with a card online and then disputes the charge with their bank — even when they don’t have a legitimate reason.

Here’s an example: After purchasing a mirror online, the buyer receives the item but later claims that the mirror was never delivered, initiating a fraudulent chargeback to obtain a refund while keeping the mirror.

Sometimes cases of friendly fraud can be accidental or unintentional. For instance, perhaps the customer didn’t recognize the company name on the bill, was unable to get any correct contact information for the company, and then disputes the transaction as fraud.

Understanding the legitimacy of cases like this can be critical in how you respond to a chargeback claim — and can help prevent chargebacks as a merchant.

What is a credit card chargeback?

A credit card chargeback refers to the chargeback dispute process initiated by a cardholder through their issuing bank or credit card company. Once the dispute is investigated, the transaction may be reversed.

What is a return item chargeback?

Despite its name, a return item chargeback isn’t a chargeback. Instead, customers receive notification of a return item chargeback if they lack the funds in their account to cover a withdrawal or the amount issued in a check.

How to prevent chargebacks as a merchant

Even if you win a chargeback dispute, your chargeback ratio can be impacted. Your chargeback ratio is the percentage of payment disputes you face relative to your total number of transactions. It’s best to keep this ratio low. A chargeback ratio under 1% is considered good.² As that number goes up, it could impact your relationship with your merchant account provider. That’s why it’s crucial to be prepared to avoid payment reversals in the first place by:

• Creating a clear return policy.
• Providing contact information, so customers can quickly get in touch with you before disputing a transaction.
• Optimizing the customer service experience and responding to customers quickly and efficiently.
• Delivering on product/premises.
• Making your business name clear on invoices, so customers know precisely who is billing them and for what.
• Creating a resolution center and resolution policy that is easily accessible to customers.
• Analyzing transactions and orders for potentially suspicious activity.
• Confirming an order or transaction with a customer before it ships.