How do Chargebacks work?

How do Chargebacks work?

A chargeback typically refers to the act of returning funds to a consumer. The action is forcibly initiated by the issuing bank of the card used by a consumer to settle a debt. Essentially what happens is a consumer disputes a transaction, and the credit card company’s bank responds by taking the money back from the merchant and returning it to the consumer.

Customers dispute charges to their credit card usually when goods or services are not delivered within the specified time frame, goods received are damaged, or the purchase was not authorized by the credit card holder — the latter being the most common reason for a chargeback.

The chargeback mechanism exists primarily for consumer protection. To start a chargeback a consumer will contact their credit card company and ask for a chargeback. At this point, the dispute process has begun. During this time the merchant will have to prove they rendered the service properly by providing a sales receipt signed by the customer within 12 business days. If the merchant can’t provide sufficient evidence, the credit card company debits the transaction amount from the merchant’s account and credits it to the consumer’s account. Additionally, the credit card company charges the merchant a chargeback fee as a penalty.

With each chargeback the issuer selects and submits a numeric reason code. This feedback can help the merchant and acquirer diagnose errors and improve customer satisfaction. The code also helps the merchant better investigate the transaction in order to find proof during the dispute process. Reason codes vary by bank network, but fall in four general categories:

  • Technical: Expired authorization, non-sufficient funds, or bank processing error.
  • Clerical: Duplicate billing, incorrect amount billed, or refund never issued.
  • Quality: Consumer claims to have never received the goods as promised at the time of purchase.
  • Fraud: Consumer claims they did not authorize the purchase or identity theft.

For transactions where the consumer signed the original invoice, the merchant may dispute a chargeback with the assistance of the merchant’s acquiring bank. The acquirer and issuer mediate in the dispute process, following rules set forth by the corresponding bank network or card association. If the acquirer prevails in the dispute, the funds are returned to the acquirer, and then to the merchant.

The merchant’s acquiring bank accepts the risk that the merchant will remain solvent over time, and thus has an incentive to take a keen interest in the merchant’s products and business practices. Reducing consumer chargebacks is crucial to this endeavor. To encourage compliance, acquirers may charge merchants a penalty for each chargeback received. Payment service providers, such as PayPal, have a similar policy. In addition, Visa and MasterCard may levy severe fines against acquiring banks that retain merchants with high chargeback frequency. Acquirers typically pass such fines directly to the merchant. Merchants whose ratios stray too far out of compliance may trigger card association fines of $100 or more per chargeback.

Tips to avoid Chargebacks

Realizing that chargebacks can gum up the steady flow of cash for your business from day to day, here are some tips that you can use to help understand chargebacks as well as help prevent them from happening.

Although chargebacks cannot be 100% gotten rid of, there are some steps that merchants can take to drastically reduce their occurrence. The more a merchant knows about processing procedures, the less likely it is a merchant will do something — or not do something — to prompt a chargeback.

Procedures for All Businesses

The first tip is pretty basic. Make sure that the business name you provide to your processor is a name your customers will recognize. This is the name that shows up on their statement. So if you happen to be Bob’s Widget Store, but the business name you provide is Really Cool Stuff LLC, you will run into increased chargebacks because your customers will not recognize the name when they get their credit card statement the next month.

Respond to retrieval requests. Both customers and card issuing banks may request copies of sales and credit drafts. Once a request is initiated a merchant needs to respond within 12 business days. Make sure your business is structured to be able to provide this paperwork quickly and easily. Host Merchant Services recommends that sales drafts should be accessible to authorized employees for 180 days after the initial chargeback notification after which they should be stored long-term in a safe and secure location.

Always get an authorization. This very basic but does need to be said.

Procedures for Retail Businesses

Retail merchants should make sure they fully comply with the transaction requirements issued annually by Visa, MasterCard and Discover Network.

Have proof the card was present by making sure you swipe all cards through your terminal and make sure to get a signature from the cardholder and compare that signature to the back of the card. Check additional identification if needed. If the card is unsigned, request a photo ID that has a signature and have the cardholder sign the card. Otherwise, do not accept the card.

Get an imprint whenever a card has to be manually keyed into a terminal.  Make sure all of the transaction information appears on the imprinted copy –– including the amount, business name, business location, and cardholder’s signature.

If a card is declined when swiped through the terminal, do not continue to try and get authorization. Instead request a new form of payment from the cardholder. Also, verify that the number on the screen matches the embossed number on the card.

Pay attention to Partial Authorization, as that can create instances where a payment gets broken into smaller amounts. For full information on Partial Authorization, you can visit Host Merchant Services article on Partial Authorization here.

You can also download Partial Authorization Guides from Host Merchant Services here.

Procedures for Internet and Mail Order/Telephone Order Businesses 

Use the Address Verification System (AVS) to ensure that your customer is providing you with the correct billing address. Discover Network requires AVS on all card-not-present transactions.

Provide your processor with a local or 800- number that they can include on your billing statement. Supplying this number for your customer will often help prevent a chargeback from occurring. Your customer can contact you directly with questions and you will have a chance to correct any misunderstandings quickly and efficiently.

When sending merchandise to a customer, use a shipping service that will be able to provide proof of delivery to the full billing address. For very expensive items, request a signature for the merchandise to be released to the buyer.

In the case of a chargeback, Host Merchant Services helps the walk merchant through the chargeback process while fighting vigorously on their behalf.  HMS strives to lower chargeback rates for all its customers, and takes a pro-active role in doing so. If your processor has not sufficiently informed you about the chargeback process, or has not taken steps to protect your business from such chargebacks, contact us immediately. Our quality assurance team can help you understand chargebacks and reduce the number of disputes you have to deal with.

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