A Merchant Primer on Customer Disputes and Chargeback Management

A Merchant Primer on Customer Disputes and Chargeback Management


Chargebacks are one of the biggest pain points for subscription merchants. It seems that with every billing cycle comes a new slew of recurring billing disputes. Not only are these pesky things time-consuming, but they’re also a serious drain on revenue. Even worse, if your chargeback ratio is above 1 percent for more than a month, your merchant account could be shut down.

Over the next three weeks, the team from Chargeback, the only technology-driven chargeback management solution on the market, will join the RevGuard blog to share our specialized knowledge of dispute resolution. The goal is to give you a comprehensive rundown of how chargebacks work, what subscription merchants should know about them, and how to prevent them from ever happening.

In this first post, we’ll outline 7 fundamentals about chargebacks and the chargeback process that all merchants should understand.

1. Definition of a Chargeback

First things first, merchants need to know what a chargeback actually is. A chargeback is a customer dispute that results in a transaction reversal where the value of the transaction is debited from the merchant’s account and credited to the account of the cardholder.

Chargebacks are the result of the card networks’ zero-fraud liability guarantee. They act as a way for consumers to protect themselves from fraudulent activity. It’s the responsibility of the merchant to provide the right compelling evidence to disprove the presence of fraudulent activity.

2. Chargebacks Start with the Cardholder

The chargeback process is long and confusing, but it all starts from one place. It all begins when a cardholder disputes a transaction. Doing so can be as simple as making a phone call or completing a few steps in an online banking portal. Either way, the issuing bank is made aware of a transaction that either appears fraudulent, represents a product or service issue, or a billing discrepancy to the cardholder.

Cardholder Ally: The Issuing Bank

At this point, the cardholder’s issuing bank may send the merchant a retrieval request. Retrieval requests ask the merchant to provide some basic transactional data that can quickly address whether or not a transaction was fraudulent. Not all chargebacks will be preceded by a retrieval request. Unfortunately, the majority of disputes skip the retrieval request process and move into a chargeback immediately.

Furthermore, not all retrieval requests will result in a chargeback. Largely because most retrieval requests are won by the merchant when a response is submitted. When retrieval requests do occur, if the merchant provides the requested evidence promptly it’s usually settled and doesn’t become a chargeback. The retrieval request typically asks for the following information where applicable:

  • Account Number
  • Expiration Date
  • Merchant Name and Location
  • Transaction Amount
  • Transaction Date
  • Description of Merchandise or Service
  • Shipping Address
  • Authorization Code
  • Cardholder Name

The issuing bank reviews the transactional information available or provided in the retrieval request to determine whether or not the dispute is valid. If the data shows no presence of merchant deception or card fraud, the chargeback process stops and the cardholder is notified. If that transactional data does suggest the presence of fraudulent activity, the chargeback process continues. The issuing bank issues an immediate credit to the customer for the disputed amount.

3. Hub of the Process: The Card Networks

As the credit is provided to the cardholder by the issuing bank, the flow of funds from the merchant’s commercial bank account to the issuing bank is initiated by the card networks. The card networks provide the data connection and pull of funds through FedWire between the process’ bookends: the issuing bank and the acquiring bank.

The card network is now aware of the chargeback and they inform the acquiring bank. Unless it’s an American Express or Discover chargeback. In this case, the two card networks act as both the issuing bank and the acquiring bank. Regardless of the flow of information, the merchant is notified by their acquiring bank of the chargeback.

Where the Fees Happen

Those fees that get tacked onto chargebacks happen during this series of hand-offs and information relays. Most acquiring banks and payment processors charge fees for every chargeback that occurs. Unfortunately, this results in merchants losing even more from chargebacks than the transaction value they represent.

4. Responding is in the Merchant’s Hands

The acquiring bank notifies the merchant of the chargeback after it is notified by the card network. Most of the time the notification comes in a mailed letter or, preferably, through an online portal and email. Now it’s up to the merchant to decide whether or not to respond to the chargeback.

Choosing Not to Respond

When merchants ignore a chargeback, the chargeback is ruled valid and the process ends. The customer keeps the transaction amount he or she was previously credited by his or her issuing bank. The merchant loses the transaction amount, customer acquisition costs, and chargeback fees.

Choosing to Respond

While the notification from the acquirer usually includes some basics on how to respond, it’s up to the merchant to gather and submit the applicable compelling evidence to respond to the chargeback. Compelling evidence is any and all information that is relevant to the particular dispute, based on the chargeback reason code used.

It’s critical to understand the reason code used to describe the chargeback, not just for the response, but for insight into business operations as well. Every business will have a unique chargeback ecosystem with its own breakdown and balance of reason codes. On average, the breakdown of reason codes seen across all major card networks is illustrated in the pie chart below.

Chargeback Reason Code Graph

For a comprehensive resource containing all 151 chargeback reason codes and full breakdowns of reason codes by card network, download the Chargeback Reason Code Encyclopedia.

Download the Encyclopedia of Reason Codes

The merchant needs to locate the compelling evidence suggested and any information that might be relevant to the transaction and customer. This evidence, or data, is held in a merchant’s payment service providers, shopping cart platforms, customer service portals, fraud scoring solutions – essentially everywhere transactional and customer data is stored.

The merchant aggregates the compelling evidence into a response letter. Response letters are formatted based on the payment service provider and the chargeback reason code. After the response letter is complete, the merchant submits it to the merchant account processor who sends it to the acquiring bank. The acquiring bank then passes the response letter to the card networks, who then pass it to the issuing bank.

5. The Issuing Bank’s Chargeback Verdict

Now that the issuing bank has the merchant’s side of the story in the form of the response letter, the decision is made as to whether the chargeback is valid or invalid. Essentially, a valid chargeback represents a customer ‘win’, while an invalid chargeback indicates a merchant ‘win’.

The Chargeback is Valid

The issuing bank will determine the chargeback to be valid if the compelling evidence does not disprove the cardholder’s claim. The value of the transaction that was originally credited to the cardholder remains in his or her account.

The Chargeback is Invalid

If the compelling evidence disproves the cardholder’s claim, the issuing bank will determine that the chargeback is invalid. The card network then pulls the funds from the issuing bank to the acquiring bank, who places them into the merchant’s commercial bank account.

6. The Chargeback Process Might Not Be Over Yet

The cardholder can persist and dispute the purchase once again with the issuing bank. Visa calls this ‘pre-arbitration’ and Mastercard refers to it as a ‘2nd chargeback’. Regardless of what it’s called, the entire chargeback process begins again and once again it’s up to the issuing bank to determine the validity of the second chargeback.

Even if the chargeback is determined to be invalid for a second time by the issuing bank, the cardholder still has one more opportunity to dispute the transaction. If the issuing bank deems it necessary, the dispute will be pushed to arbitration. A fee of $250 is automatically charged to the merchant here. If the chargeback is proven invalid for the third time, the $250 fee is returned to the merchant. However, if the chargeback is finally proven valid, the merchant is charged an additional $250 on top of the original fee.

However, if you follow best practices regarding chargeback responses, all compelling evidence available is submitted in the initial response. By providing all of the compelling evidence in the first response, a merchant is able to skip pre-arbitration. Unless new compelling evidence, like documented customer communications, is available.

7. The Chargeback Aftermath

Phew! We made it through the chargeback unscathed. Now what? Well, when a merchant chooses to respond to a chargeback, they end up with valuable data regarding business operations and fraud solution efficacy. As you just learned, a chargeback is determined to be either valid or invalid. But the implications that ‘win’ or ‘loss’ carries is where the value really lies. Merchants who don’t respond to chargebacks miss out on this treasure trove of business intelligence.

When a Merchant Loses a Chargeback

There are two reasons that a chargeback is determined to be valid after a merchant submits a comprehensive response. The first reason is true fraud. Here, the cardholder was a legitimate victim of identity fraud where his or her credit card information stolen and used to make a purchase. A merchant’s fraud prevention solutions safeguard against this type of fraud from happening and resulting in chargebacks.

The second reason a merchant loses a chargeback is due to product or service issues. Whether the product wasn’t as described, defective, or never showed up, the merchant is responsible for fulfilling orders as agreed upon. Product or service issue related chargebacks can easily be avoided by simply being an honest merchant. But a lenient return policy and stellar customer service can also prevent these types of chargebacks.

Chargeback Process Flowchart

When a Merchant Wins a Chargeback

There are also two reasons a chargeback could be determined to be invalid after the compelling evidence is reviewed by the issuing bank. While it’s great that the merchant won the chargeback and retained the transaction value, it also means that a cardholder either committed friendly fraud or chargeback fraud. Distinguishing between friendly fraud and chargeback fraud is critically important. It means the difference between mending and ending a customer relationship.

There’s nothing sinister about friendly fraud. With friendly fraud a cardholder either misunderstood, didn’t recognize, or simply forgot the transaction occurred. Merchant’s should open up lines of communication with these particular customers to learn about what changes, if any, can be made to make their merchant descriptor or other post-purchase communications clearer to users.

However, there’s certainly something sinister about chargeback fraud. A cardholder commits chargeback fraud when he or she knowingly and purposefully abuses chargeback rights to get a transaction refunded. If products were acquired by the customer, he or she will attempt to retain those and be reimbursed for the product’s value. Merchants should consider blacklisting cardholders who commit chargeback fraud to prevent any further losses.

As you can see, chargebacks live up to their confusing reputation. The process can take many different routes and the participation from merchants is critical. And we haven’t even talked about the role chargebacks play as lagging indicators for business operations. Particularly, the chargeback reason codes to which subscription merchants should pay close attention. In the second part of this series, we’ll examine chargebacks with even more scrutiny; zeroing in on recurring billing reason codes and what they mean for subscription merchants.

Looking for information beyond this Chargeback.com article? Visit the Chargeback blog for more awesome articles. If you’re ready to find out how RevGuard works with Chergeback.com to provide a complete chargebacks solution – contact us!

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