One of the nuances of the US credit card industry is the power that the system grants the consumer. A consumer can always contest a charge on her credit card bill. This facet of the credit card industry keeps consumers feeling secure that they can always fight fraud.
But with this power comes responsibility. Some consumers can abuse the system. Chargebacks can range from a customer honestly returning something he didn't really mean to purchase to the completely fraudulent. What's good for consumers can come at the cost of merchants, who bear the costs of chargebacks.
Payment and fintech providers, like Stripe which just introduced its own chargeback protection, offer tools and solutions to help protect merchants from fraudulent chargebacks.
What's going on with chargebacks?
When a consumer disputes a charge on his credit card, he can do so by contacting the merchant where he bought the item or service. If the merchant goes along with the consumer's request, that's a refund.
But with credit cards, the consumer can also forcibly reverse a charge by contacting his issuing bank. In today's market, issuing banks provide really good customer service and because of that, consumers will often contact their bank first if there's a dispute. Banks have become the de facto customer service center for merchants because consumers don’t want to contact a merchant and get pushback.
If the bank approves the reversal, the bank forcibly returns money to the consumer from a merchant's account. That's a chargeback. Sometimes, the merchant doesn't find out until after the refund has occurred.
Aren't chargebacks good for the customer?
In a way, chargebacks were a boon to consumers and helped propel the growth of the credit card industry. Chargebacks protect cardholders from unscrupulous merchants. The fact that a consumer can do a chargeback puts pressure on merchants to sell high quality merchandise and provide good service.
With a chargeback, the cardholder sometimes comes out smelling like roses, even if he's committed fraud. The consumer gets to keep the item he purchased and gets the cost of the item refunded from the merchant. The merchant essentially has to pay twice.
How big a problem are chargebacks?
Typically, chargebacks account for a half a percent or one percent of a merchant’s business. But when you look at the total related costs associated with chargebacks, they can run up to ten percent of the merchant’s payment costs. Javelin Strategy and Research estimated the total cost of chargebacks to total $31 billion.
That study found some other metrics associated with chargebacks:
- Merchants are burdened with two-thirds of total costs related to chargebacks
- 60 percent of merchant chargeback costs are in management expenses
- For every $1 disputed, merchants and issuers incur $1.50 in more costs
How does chargeback protection help a merchant?
Because it's a large and growing market, there are a variety of techniques, technologies, and processes merchants can use to prevent chargebacks.
One way is to address chargebacks is by addressing the process before a merchant bills a card. In this pre-authorization stage, you can try harder to make sure that the transaction is legitimate. But, if the authorization process is too onerous, a merchant runs the risk of turning away good purchases. Most solutions providers focus on this stage. Companies like Riskified and Signifyed, as well as Stripe and Square, typically take this approach.
Verifi, for example, focuses on what happens after authorization. The company has workflows built into some of the major banks. They step in when a bank receives a complaint from a consumer but before it’s filed a chargeback. The complaint is routed to the merchant, who is given a chance to resolve the complaint before it becomes a chargeback.
What does chargeback protection cost?
There's a cost to chargeback protection. Merchants that receive this type of protection from the payment processor typically pay a percentage of the transaction. It's like an insurance policy that shifts the responsibility of chargebacks to the processor and off the merchant. Stripe's new Chargeback Protection costs 0.4% per transaction, for example.