What is a chargeback? Guide for startups and SMEs

At some point in your startup, you’ll get a message from your credit card processor or bank saying that one of your customers has initiated a chargeback.

The first time this happens, you begin to worry:
‘Could the bank shut down my account?’
‘Did I do something illegal?’
‘Should I expect more of these?’
‘How normal is this?’

In this article, Che Sampat, CEO and co-founder of ChargebackStop, explains what a chargeback is, how often it happens, what to do if you get one and what you can do to avoid getting more.

Contents

• What is a chargeback?
• Should I care about chargebacks?
• How many chargebacks are too many?
• How often do chargebacks happen?
• What’s the average rate of chargebacks for other companies in my sector?
• Will chargebacks affect my company’s reputation?
• If I dispute a chargeback, how likely is it that I’ll win?
• Should I dispute a chargeback with the bank?
  Or settle it with the customer and have them cancel the dispute?
• What can I do to avoid chargebacks?
• FAQs: Chargebacks

What is a chargeback? ⏪

A chargeback is like a transaction rewind button.

After a cardholder purchases something, their money transfers through to the merchant.

If the cardholder is displeased with the purchase, they contact the bank that issued the credit card (the issuing bank) and file a dispute. The cardholder might dispute the charge for a variety of reasons such as a processing error or goods not received.

Basically, the cardholder is pressing the rewind button on the transaction. They want their money back.

The merchant can respond to the dispute by providing compelling evidence. The issuing bank then decides who’s in the right.

If the bank agrees with the merchant, the refund is cancelled, and the merchant keeps the money. Otherwise, there is a chargeback, and the issuing bank debits the merchant and returns the money to the cardholder.

The charge has been rewound. It is now a chargeback.

Should I care about chargebacks? 🤷‍♂️

You should consider chargebacks from the very start of your business operations. The financial impact can be damaging as well as time-consuming. There is an implicit risk to your company’s viability and reputation if chargebacks go unchecked.

• Financial impact
  Direct costs, incremental fees and operational costs all rise with excessive chargebacks. Also, these costs may increase if a company is categorised as ‘high-risk’. There are severe monthly fines for high-risk merchants.
• Time spent
  Your team may spend inordinate amounts of time gathering proof of compliance and responding to representment inquiries, but even then end up losing the dispute and the sale.
• Implicit risks
  A company’s chargeback rate threshold may be viewed as excessive. If so, the company is automatically entered into various monitoring programs, such as the Visa Dispute Monitoring Program (VDMP). Your company’s reputation is on the line at this point. And so is the company’s ability to use credit card services.

How many chargebacks are too many? 🧮

More to the point, you might be asking, ‘What percentage of all transactions can I expect to be charged back?’

The general industry standard for an acceptable chargeback ratio is around 1% of transactions.

However, each card network (such as Visa, Mastercard, American Express etc) has its own thresholds for acceptable chargeback ratios, typically expressed as a percentage of transactions.

This means that if more than 1% of your transactions result in chargebacks, it could be considered ‘too many’, depending on the card network.

• Visa: Visa’s chargeback threshold is usually set at a 0.9% chargeback-to-transaction ratio and a 1% chargeback-to-sales volume ratio
• Mastercard: Mastercard often uses a threshold of 1% or 100 monthly chargebacks.
• American Express and Discover: These networks also have similar thresholds but may have different criteria for evaluating risk.

How often do chargebacks happen? ⏱️

Chargebacks happen regularly, especially to e-commerce and companies with a significant online presence. But it depends. (Don’t worry, I’ll explain solutions and prevention later in this post.)

Here are some of the factors affecting chargeback frequency:

• Industry
  Specific industries experience higher rates of chargebacks. For example, businesses in the travel, entertainment and luxury goods sectors often see more chargebacks due to the high-value nature of transactions.
• Business size and volume
  Larger businesses or those with high transaction volumes experience more chargebacks due to the sheer number of transactions processed.
• Type of product or service
  Digital goods, subscription services and high-ticket items are more susceptible to chargebacks. This is partly due to ‘buyer’s remorse’ or fraud.
• Fraud prevention measures
  Companies with robust fraud prevention and detection systems may experience fewer chargebacks. Effective customer service can also reduce the incidence of chargebacks.
• Type of customers
  Companies that serve markets or customer segments with higher incidences of fraud or disputes may see more chargebacks.

What’s the average rate of chargebacks for other companies in my sector? 🤔

Chargeback rates vary significantly across different sectors. Here are some average chargeback rates in various industries:

• Retail
  Retailers typically see lower chargeback rates, often below 1%. Online retail might have slightly higher rates due to the prevalence of CNP (Card Not Present) transactions.
• Travel and hospitality
  This sector often experiences higher chargeback rates, possibly exceeding 1%, due to cancellations, travel plan changes, and service disputes.
• Digital goods and services
  These businesses can see varied chargeback rates, often higher due to unauthorised transactions, dissatisfaction with digital content or misunderstanding how subscription billing works.
• Subscription services
  Recurring billing models are prone to higher chargebacks due to customers forgetting about recurring charges or being dissatisfied with the cancellation process.
• High-value items (electronics, jewellery etc)
  Higher ticket sizes can lead to higher chargeback rates due to ‘buyer’s remorse’ or fraud.
• Food and beverage
  Typically, this sector has lower chargeback rates, but online orders and delivery services can see higher rates due to problems with the accuracy or delivery of orders.

Will chargebacks affect my company’s reputation? 😳

An average number won’t negatively affect your business. But after a certain number, your reputation will suffer. Excessive chargebacks will affect your bottom line, too.

Chargebacks can also affect different aspects of your business reputation:

• Customer trust and satisfaction
  Frequent chargebacks can indicate to customers that your business might be unreliable or not delivering as promised. This can erode trust and satisfaction, leading to negative reviews and bad word-of-mouth advertising. Negative reviews and posts are highly visible and can significantly damage your company’s reputation and perceived reliability.
• Your relationship with payment processors and banks:
  Excessive chargebacks can flag your business as high-risk to payment processors and banks. This could lead to higher transaction fees, stricter contract terms or even the loss of your merchant account, damaging your ability to process payments.
• Brand image
  The reasons behind chargebacks, whether product quality, customer service or transaction issues, can reflect poorly on your brand and its values, affecting long-term brand perception and viability.
• Financial stability and growth
  Repeated chargebacks not only lead to direct financial losses in the form of returned funds, additional fees and penalties. They can also signal poor financial management or business health to investors, partners and financial institutions.

If I dispute a chargeback, how likely is it that I’ll win? 🏆

There isn’t a one-size-fits-all answer to this. The likelihood of successfully disputing a chargeback varies based on several factors:

• Reason for chargeback
  The reason for the chargeback claim significantly influences the outcome. For instance, disputes over unauthorised transactions might be harder to win than those related to service quality or non-delivery of goods.
• Evidence you submit
  You’ll need to provide compelling evidence. This includes transaction records, proof of delivery, communication logs with the customer and any other documentation that supports your case.
• Type of product or service
  Tangible goods with explicit delivery tracking are often easier to defend than intangible services or digital products, where proof of delivery or satisfaction can be more subjective.
• Response time and quality
  Prompt and detailed responses to chargeback claims can improve your chances. Make sure you hit the deadlines and follow the procedures set by the credit card networks.
• History of chargebacks
  Businesses with a lower frequency of chargebacks might be viewed more favourably compared to those with a high frequency, because a higher frequency can make the merchant appear less credible.
• Your acquiring bank and payment processor
  Some banks and processors offer more effective support to merchants in the dispute process.
• Policies of the customer’s credit card company
  Credit card companies have different policies and thresholds for deciding chargeback disputes.

In general, industries with physical goods that can be tracked and documented tend to have a higher success rate in disputing chargebacks than services or digital goods industries. However, even with the best evidence, there’s no guaranteed outcome.

We recommend you approach each dispute separately, submit accurate and thorough evidence, and understand and comply with the guidelines of the specific card network. Additionally, focus on preventing chargebacks through clear communication, excellent customer service and robust fraud prevention measures. Prevention is often more effective than relying on succeeding in disputes. In short, prevention is better than fighting.

Should I dispute a chargeback with the bank?
Or settle it with the customer and have them cancel the dispute? 🤝

Let’s look at the pros and cons of this situation. To decide whether to dispute a chargeback directly with the bank or to try to settle with the customer, you’ll need to consider the specific circumstances of the chargeback.

Here are some points to consider for each approach:

Disputing with the bank

Pros:

• Formal process: The dispute process is structured, and you can present evidence to support your case.
• Record keeping: Successfully disputing a chargeback can help maintain your reputation with banks and payment processors.
• Policy adherence: If you dispute with the bank, you adher to the chargeback process as outlined by the credit card networks.

Cons:

• Time and resources: Disputing a chargeback can be time-consuming and resource-intensive.
• No guarantee you’ll succeed: There’s no certainty you’ll win the dispute, even with solid evidence.
• Potential impact on relationships: An official dispute process might be more contentious and affect your relationship with customers.

Settling with the customer

Pros:

• Customer relations: Direct resolution can improve customer satisfaction and potentially retain the customer.
• Faster resolution: It might be quicker than the formal dispute process.
• Control over outcome: You have more control over the terms of the settlement.

Cons:

• Risk of non-cooperation: The customer might not agree to cancel the dispute or might not follow through.
• No impact on chargeback ratio: Even if you settle, the chargeback might still count against your chargeback ratio with your bank or card processor.
• Precedent for future disputes: Settling could set a precedent, encouraging other customers to initiate chargebacks expecting similar settlements.

How to decide

• Assess the situation: What’s the reason for the chargeback? Is it a misunderstanding, service issue or fraud?
• Communication: It might be worth reaching out if you believe there’s a chance to resolve the issue with the customer amicably. Clear, honest communication can sometimes lead to a quick resolution.
• Evidence and likelihood of success: Disputing through the bank might be more appropriate if you have strong evidence to support your case.
• Customer value: What’s the long-term value of this customer? If retaining the customer is essential to your business, it might be better to try to settle.

In many cases, an initial attempt to resolve the issue directly with the customer can be beneficial. If that fails or the customer is unresponsive or uncooperative, the next step is to proceed with a formal dispute through the bank. Document all your interactions with the customer and keep detailed records, because this information can be valuable in either scenario.

What can I do to avoid chargebacks? 🛡️

Great question. To maintain and enhance your company’s revenues and reputation, you should take a proactive approach to managing and reducing chargebacks.

Here are some specific things you can do:

1. Understand why chargebacks occur and address root causes
2. Ensure clear customer communication about products, services, and policies
3. Offer excellent customer service to resolve issues before they escalate to chargebacks
4. Implement automated fraud detection and prevention measures, via a service such as ChargebackStop

By avoiding chargebacks, you’ll grow your revenues, reputation and even your business viability. And you can prevent most chargebacks.

Keep reading for our quick list of frequently asked questions about chargebacks.

FAQs: Chargebacks

What is a chargeback?

A chargeback is a reversal of a credit card transaction initiated by the cardholder via their bank. It occurs when a customer disputes a charge on their card statement and requests the transaction amount to be returned.

Why do chargebacks occur?

Chargebacks can happen for various reasons, including unauthorised use of the card, dissatisfaction with the product or service, non-receipt of goods or services or billing errors.

What is the chargeback process?

The process begins when a customer files a dispute with their bank. The bank then notifies the merchant, who has an opportunity to respond with evidence to support the legitimacy of the transaction. The bank reviews the evidence and decides the outcome.

What is a chargeback ratio?

A chargeback ratio is the percentage of a merchant’s transactions that result in chargebacks. It’s calculated by dividing the number of chargebacks by the total number of transactions in a given period.

What are the time limits for responding to chargebacks?

Time limits vary by card network but typically range from 20 to 45 days from the date the chargeback is issued. Merchants must respond promptly within these timeframes.

What’s the difference between a chargeback and a refund?

A refund is initiated by the merchant when a customer returns a product or is dissatisfied with a service. In contrast, a chargeback is initiated by the customer through their bank, often without informing the merchant.

How can merchants prevent chargebacks?

Merchants can reduce chargebacks by offering excellent customer service, clear communication about products and services, accurate billing and robust fraud detection measures.